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THE  LIBRARY 

OF 

THE  UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 


THE  THEORY  OF 

EARNED  AND  UNEARNED 

INCOMES 


A  STUDY  OF 
THE  ECONOMIC  LAWS  OF  DISTRIBUTION 

WITH  SOME  OF  THEIR  APPLICATIONS  TO  SOCIAL 

POLICY 


BY 

HARRY  GUNNISON  BROWN 

PROFESSOR   OF   ECONOMICS     IN    THE     UNIVERSITY    OF     MISSOURI 


A :.'.hor  of 
'Principles  of  Commerce' 


QIalumbia.  fHtUisaurt 

MISSOURI   BOOK   COMPANY 

1918 


Copyright,  1918 

By  Missouri  Book  Company 

Published  September,  1918. 


Press  of 
E.   IV-  Stephens  Publishing  Co., 
Columbia,  Missouri. 


PREFACE 

The  study  here  offered  is  intended  to  appeal  to 
several  classes  of  readers.  My  hope  is  that  it  will 
be  read  by,  among  others,  socialists  of  the  Marxian 
school,  single  taxers,  and  economists.  For  those 
orthodox  or  Marxian  socialists  who  are  willing  to 
reexamine  the  theoretical  foundations  of  their  doc- 
trines, interest  will  attach  to  the  classification  of 
incomes  and  to  the  attempt  to  distinguish  between 
incomes  which  are  earned  and  incomes  which  are 
unearned.  The  Marxian  view  that  all  income  from 
'property  is  "surplus  value"  and  represents  exploita- 
tion, is  not  accepted,  but  it  is  made  clear  that  some 
income  from  property — as,  indeed,  from  labor  also 
— is  unearned.  To  single  taxers  the  discussion,  in 
Chapter  VI,  of  land  rent  and  its  taxation  will  per- 
haps be  of  chief  interest,  but  the  rest  of  the  book 
leads  up  to  and  supplements  the  chapter  on  land 
rent  in  a  way  to  make  the  whole  study  significant 
for  this  class  of  readers.  I  venture  to  hope,  also, 
that  professional  economists,  as  such,  will  find 
enough  of  critical  and  constructive  material  in  the 
text  and  footnotes,  to  make  the  study  of  interest 
to  them.  Finally,  the  book  is  intended  to  make  an 
appeal  to  serious  readers  of  no  particular  school  or 
of  any  school  of  thought  and  of  any  business  or 
profession,  who  are  concerned  with  the  evils  in  our 
present  economic  system  and  who  look  forward  to 
worth-while  changes  during  or  after  the  war. 
World-wide  democracy  will  be  but  half  achieved  if 
it  be  achieved  in  the  political  realm  only,  with  no 
accompanying  economic  changes. 

V 

93-^ 


VI  Preface 

I  am  under  obligation  to  the  Quarterly  Journal 
of  Econcmics  for  permission  to  republish,  sub- 
stantially without  change,  the  major  part  of  an 
article  on  "The  Marginal  Productivity  versus  the 
Impatience  Theory  of  Interest,"  first  published  in 
August,  1913.  To  the  American  Economic  Revieiv 
I  am  indebted  for  permission  to  use,  also  in  Chap- 
ter IV,  most  of  an  article  on  "The  Discount  versus 
the  Cost-of-Production  Theory  of  Capital  Valua- 
tion," originally  published  in  June,  1914.  To  the 
Journal  of  Political  Economy  I  am  indebted  for 
permission  to  republish,  in  Chapter  VI,  along  with 
later  additions,  an  article  on  "The  Ethics  of  Land- 
Value  Taxation,"  which  appeared  in  May,  1917. 
The  Macmillan  Company  have  kindly  consented  to 
the  use  in  Chapter  I  of  this  book,  of  about  eight 
pages  taken  from  the  first  two  Chapters  of  my 
Principles  of  Commerce,  published  by  them.  Pro- 
fessor H,  J.  Davenport  of  Cornell  University  has 
given  the  manuscript  a  conscientious  and  critical 
overhauling  and  although  I  have  not  been  able  to 
accept  all  of  his  suggestions,  the  book  has  been  im- 
proved because  of  his  criticisms.  To  my  wife  I 
owe  thanks  for  a  careful  and  critical  reading  of  the 
entire  manuscript  and  for  reading  the  proof. 

Harry    Gunnison    Brow^n 
Columbia,    Mo. 
May,   1918. 


SUGGESTIONS  TO  READERS 

To  the  general  reader  whose  time  or  patience 
may  not  permit  his  following  the  more  difficult 
parts  of  the  argument  set  forth  in  the  succeeding 
pages  but  who  nevertheless  seeks  an  understanding 
of  the  principal  practical  conclusions  reached,  it  is 
suggested  that  Chapters  I,  II  and  IV  (but  not  the 
Introduction)  be  entirely  omitted,  along  with  the 
critical  footnote  discussions  in  the  other  chapters. 
But  Chapter  IV  cannot  fairly  be  omitted  by  the 
reader  who,  familiar  with  the  controversial  liter- 
ature on  the  theory  of  the  interest  rate,  has  tenta- 
tively adopted  a  conclusion  in  disagreement  with 
that  presented  herein.  Nor,  indeed,  should  the 
critically-minded  reader  fail  to  glance  at  the  foot- 
notes, since  these  are  inserted  in  many  cases  for 
the  express  purpose  of  meeting  anticipated 
criticisms. 


VII 


SUMMARY  OF  CHAPTER  TOPICS 

INTRODUCTION— THE  POINT  OF  VIEW. 

CHAPTER      I.  THE  DETERMINATION  OF  VALUE. 

CHAPTER    II.  ULTIMATE  DETERMINANTS   OF  VALUE. 

CHAPTER  III.  THE  CAUSES  OF  INTEREST. 

CHAPTER   IV.  THE  RATE  OF  INTEREST. 

CHAPTER     V.  WAGES  AND  POPULATION. 

CHAPTER  VI.  THE  RENT  OF  LAND  AND  ITS  TAXATION. 


VIII 


CONTENTS  BY  SECTIONS 

Introduction. 
THE     POINT     OF     VIEW     3-4 

CHAPTER  I. 
THE  DETERMINATION  OF  VALUE 5-+S 

§   I     Value,  or  the  Analogue  of  Value,  to  the  Isolated  Man. 

§  2     Conditions  Determining  the  Extent  of  an  Isolated  Man's  Pro- 
duction- 

§  3     Utility,   Relative   Production   of   Different    Goods,    and    Value, 
in  a   Modern  Community. 

§  4     Demand  and  Supply  in  Relation  to  Price. 

§   5     Exxilanations  and  Qualifications. 

§    6     Speculation  in  Relation  to  Price. 

§   7     The  Determination  of  the  General  Level  of  Prices. 

§  8     The  Relation  of  Commercial  Banking  to  the  General  Level  of 
Prices. 
-§  9     Summary. 

CHAPTER  II. 
ULTIMATE  DETERMINANTS  OF  VALUE 46-75 

§    I  Supply  of  One  Good  Means  Demand  for  Other  Goods. 

§  2  Influences  Back  of  Demand. 

§   3  Influences  Back  of  Supply. 

§  4  Labor  Costs  in  Production. 

§   5  Land  and   Capital   Costs  in  Production. 

§   6  The  Value  of  Land. 

§  7  Joint  Demand  and  Joint  Supply. 

§  8  Summary. 

CHAPTER  III. 
THE  CAUSES  OF  INTEREST 76-1" 

§    I     The   Factors  of   Production. 
§  2     The  Accumulation  of  Capital. 

IX 


X  Contents  by   Sections 

§  3  The  Productivity  of  Capital. 

§  4  Capital  Accumulation  versus  Marginal  Capital  Productiveness. 

§  5  Saving  or  Abstinence  in  Relation  to  Interest. 

•V  §  6  Summary. 

CHAPTER  IV. 

THE  RATE  OF  INTEREST    112-170 

§  I  The  Choices  of  a  Crusoe- 

§  2  The  Demand  for  Present  Goods. 

§  3  The  Supply  of  Present  Goods  Offered  for  Future  Goods. 

§  4  Demand  for  and  Supply  of  Present  Goods  Further  Considered. 

§  5  A    Concrete    Illustration. 

§  6  Interest  in  a   Money  Economy. 

§  7  Changing  Bank  Reserves  in  Relation  to  Interest. 

§  8  Rising  and  Falling  Prices  in  Relation  to  Interest. 

§  9  Some  Further  Complications  in  the  Actual   Industrial  World. 

§  10  Interest  Earned   and   Unearned. 

^  §  II  Summary. 

CHAPTER  v^. 

WAGES  AND  POPULATION  171-198 

§   I     The  Proximate  Determination  of  Wages. 

§  2     Influence  of  Physical   and  Influence  of  Value  Productivity  en 

Wages. 
§   3     Comparative  Wages  in  Different  Labor  Groups. 
§  4     A  Side  Light  on  the  Interest  Problem. 
§   5     General    Wages   and    Population. 
§  6     Immigration   and  Wages. 
^  §  7     Summary- 

CHAPTER  VI. 

THE  RENT  OF  LAND  AND  ITS  TAXATION 199-254 

§   I     Land  Rent  as  a  Marginal  Product  of  Land. 

§  2     Land   Rent  versus  Capital   Interest. 

§   3     Land  Rent  as  an   Unearned  Income. 

§  4  Improvements  by  Special  Assessments  and  the  Right  of  Land- 
owners to  a  Rental  Return. 

§   5     Other  Services  of  City  Landowners. 

§  6  The  Increment  of  Land  Values  in  Relation  to  the  Settlement 
of  the  American  West. 


Contents   by  Sections  xi 

§  7  Ownership  of  Land  by  omall-Fa-inily  Groups  versus  Increas- 
ing Population  in  Other  Croups. 

§  8  The  Bearing  of  the  Contention  that  there  may  be  Other  Un- 
earned Increments  not  Especi;.lly  Associated  with   Land. 

§  9     The  Taxation  of  Future  Increments  of  Value. 

§  lo  Land-Value  Taxation  in  Relation  to  the  Theory  of  Vested 
Rights. 

§    II   A  Few  Additional  Considerations. 

§    12  Summary. 


THE   THEORY  OF 

EARNED  AND  UNEARNED 

INCOMES 


Briefly,  then,  the  universal  basis  of  co-operation  is  the  proportion- 
ing of   benefits   received   to  services   rendered. 

Herbert  Spencer 

He  who  by  any  exertion  of  mind  or  body  adds  to  the  aggregate 
of  enjoyable  wealth,  increases  the  sum  of  human  knowledge  or  gives 
to  human  life  higher  elevation  or  greater  fullness — he  is  in  the 
large  meaning  of  the  words,  a  "producer,"  a  "workingman,"  a  "la- 
borer," and  is  honestly  earning  honest  wages.  But  he  who  without 
doing  aught  to  make  mankind  richer,  wiser,  better,  happier,  lives 
on  the  toil  of  others — he,  no  matter  by  what  name  of  honor  he  may 
be  called,  or  how  lustily  the  priests  of  Mammon  may  swing  their 
censers  before  him,  is  in  the  last  analysis  but  a  beggarman  or  a 
thief. 

Henry  George 


(2) 


THE  THEORY  OF 
EARNED  AND  UNEARNED  INCOMES 


INTRODUCTION 

THE   POINT   OF   VIEW 

The  science  of  economics  may  be  pursued,  as 
may  any  science,  purely  for  its  own  sake.  Its 
pursuit  may  be  an  intellectual  amusement  of  the 
cultured,  and  the  contemplation  of  its  conclusions 
may  be  enjoyed  by  its  votaries  as  one  would  enjoy 
a  great  epic.  But  the  study  of  economics  may 
also  furnish  guidance  in  matters  of  social  policy 
and  may  thus  serve  two  ends  of  which  the  second 
is  probably  by  far  the  more  important. 

In  attempting,  through  the  succeeding  pages,  to 
outline  a  theory  of  earned  and  unearned  incomes, 
we  shall  not  be  able  to  lose  sight  of  this  second 
end.  We  shall,  indeed,  be  continually  inquiring 
hoiv  economic  forces  work,  e.  g.,  what  influences 
fix  value  and  price,  what  are  the  conditions  which 
cause  interest  to  be  paid,  how  interest  rates  are 
determined,  what  conditions  fix  wages,  what 
influences  make  land  rent  rise  or  fall.  But 
back  of  our  search  for  these  scientific  laivs  there 
will  lie  a  purpose  and  a  point  of  view.  The 
purpose  will  be  to  find  out  those  things  in  the 
theory  of  income  distribution  the  knowledge  of 
which  may  help  us  to  the  fairest  possible  economic 
organization  of  society.  The  point  of  view  will  be 
some  notion  as  to  what  tests  determine  whether  an 
income  is  earned  or  not  and   some  sort  of  ideal 

(3) 


4  Earned  and  Unearned  Incomes 

regarding  the  desirability  of  permitting  individuals 
to  enjoy  incomes  which  are  not  earned.  With 
certain  qualifications  which  will  become  clear  as 
our  investigation  proceeds,  we  shall  regard  in- 
comes as  earned  when  equivalent  service  is  given 
by  their  recipients  to  those  from  whom  the  incomes 
are  ultimately  drawn ;  and  we  shall  regard  incomes 
as  unearned  when  their  recipients  enjoy  them 
without  making  a  corresponding  return. 

Whether  such  a  distinction  has  any  significance 
for   any   individual   reader,   will   depend   much   on 
his  ethical  viewpoint,  his  general  social  philosophy. 
To  one  who  regards  absolute  equality  of  incomes 
as  the  economic  ideal,  however  great  the  differences 
in    efficiency,   an    investigation   into    the    question 
whether  various   incomes  are   earned  or  not,   will 
seem    irrelevant.      Likewise,   to   one   who   regards 
the  existence  of  privileged   classes  drawing  large 
incomes,  as  a  desirable  condition  of  economic  and 
social   life,   there   will   be   little   significance    in   a 
conclusion  that  many  of  these  large  incomes  are 
wholly  or  partly  unearned.     But  there  are  persons 
who  believe,  more  or  less  on  utilitarian  grounds, 
that  economic  society  is  not  well  organized  unless 
incomes  have  some  reasonable  relation  to  service 
rendered   by  the   recipients  to   those   from   whom 
the    incomes    are    in    the    last    analysis,    received, 
and  that  no  class  of  citizens    (unless  by  way  of 
charitable  relief)    should  be  privileged  to  receive 
incomes  not  based  on  such  service.    To  persons  who 
hold  this  view,  an  analysis  of  incomes  which  leads 
eventually  to  their  classification  as  earned  and  un- 
earned may  seem   in  very  truth  to  constitute  the 
first  step  of  an  inquiry  into  the  nature  and  possi- 
bility of  economic  democracy. 


CHAPTER  I 

THE  DETERMINATION  OF  VALUE 

§  1 

Value,  or  the  Analogue  of  Value,  to  the  Isolated 

Man 

By  value,  in  the  sense  of  value  in  exchange,  we 
ordinarily  mean  the  number  of  units  of  some  other 
good  or  goods,  taken  as  a  standard  or  measure  of 
values  that  any  given  article  or  immaterial  benefit 
will  bring  in  trade.  Thus,  the  value  of  a  man's  horse 
may  be  150  bushels  of  wheat  or  30  tons  of  coal  or 
75  days  of  common  labor  or  two  dozen  operatic  per- 
formances. The  thought  is  that  the  horse  would  sell 
for — would  bring  in  exchange — such  an  amount  of 
other  goods.  Since  money  is  the  medium  by  which 
exchanges  are  commonly  effected  and,  therefore,  a 
generally  recognized  measure  of  value,  we  ordinarily 
express  exchange  relations  in  terms  of  money.  We 
would  be  much  more  likely  to  state  the  value  of  the 
horse  as  $160  than  to  state  it  as  (for  example)  30 
tons  of  coal.  Everyone  sells  goods  for  money  or 
buys  goods  with  money  or  both.  Everyone  is  toler- 
ably familiar  with  the  value  of  the  money  unit  in 
terms  of  various  other  goods.  Everyone  knows,  that 
is,  about  how  much  of  various  other  goods  a  dollar 
will  buy.  Consequently  the  statement  that  a  horse 
is  worth  $160  includes  the  other  statements  and 
can  be  readily  translated  into  them.     Valuation  of 

1  Jevons,  The  Theory  of  Political  Economy,  fourth  edition,  London 
(Macmillan),    1911,   pp-   78-83. 

(5) 


6  Earned  and  Unearned  Incomes 

goods  in  terms  of  money  is  really  valuation  of  them 
in  terms  of  goods-in-general. 

Exchange  value  is  a  social  phenomenon.  It  in- 
volves the  exchanging  of  one  kind  of  goods  for 
another  kind  (or  kinds)  of  goods  and  a  comparison 
of  the  utility  or  desirability  of  the  one  kind  with 
that  of  the  other.  Such  a  comparison  will  presuma- 
bly be  made,  in  fact,  by  both  parties  to  an  exchange. 
But  though  exchange  value  is  thus  a  phenomenon 
involving  human  relations  as  well  as  involving 
goods  and  so  is  a  social  phenomenon,  nevertheless 
nearly  all  of  the  factors  that  enter  into  its  deter- 
mination exist  in  a  state  of  isolation  such  as  that 
of  a  Robinson  Crusoe.  And  so  we  may,  perhaps, 
with  advantage,  begin  our  study  of  value  by  a 
consideration  of  the  comparisons  that  might  enter 
the  mind  of  a  Crusoe  who,  alone  on  his  island,  is 
engaged  in  eking  out  a  precarious  living.  To 
Crusoe,  as  to  a  man  in  the  most  advanced  modern 
community,  must  be  presented  frequently  the 
necessity  of  making  a  choice  among  different 
commodities,  all  of  which  together  he  can  not 
secure  in  anything  like  the  number  or  quantity 
desired,  and  all  of  which,  possibly,  he  cannot  use, 
since  some  may  be  substitutes  for  others.  He  must, 
therefore,  compare  the  utilitv  of  one  kind  of 
goods  with  the  utility  of  something  else.  It  may 
be  that  he  has  occasion  to  decide  whether  a  month's 
labor  which  he  can  spare  from  other  purposes 
shall  be  used  to  build  an  additional  room  to  his 
hut  or  dugout,  or  whether  it  shall  be  used  to  make 
him  a  canoe;  whether  today's  efforts  shall  be 
devoted  to  killing  and  dressing  a  goat  or  whether 
the  day  shall  be  spent  in  catching  fish.     There  is, 


The  Determination  of  Value.  7 

of  course,  for  Crusoe,  no  value  in  the  sense  of 
power  in  exchange,  since  there  is  no  one  with 
whom  exchanges  can  be  made.  But  there  is  value, 
if  we  may  use  the  term  in  an  analogous  case,  in 
the  sense  of  comparison  of  one  thing  with  some 
other  thing  or  things,  i.  e.  there  is  comparative 
utility.  If  Crusoe  would  rather  spend  a  month's 
labor  which  he  has  available,  in  building  an  ad- 
ditional room  than  in  constructing  a  canoe,  it  is 
probably  because  the  utility  of  the  room  is  greater 
to  him  than  the  utility  of  the  canoe,  or,  at  any 
rate,  that  he  believes  it  to  be  greater.  If  he 
could  make  the  canoe  in  two  weeks  and  a  new 
goat-skin  suit  in  another  two  weeks  but  would 
rather  devote  all  four  weeks  to  building  the 
additional  room,  then  the  room  has  greater  utility 
to  him  than  the  canoe  and  suit  together;  or,  if 
the  canoe  and  suit  are  reckoned  equal,  the  room 
has  more  than  twice  the  utility  of  either.  Were 
Crusoe  in  a  small  community  with  several  other 
inhabitants,  he  would  perhaps  be  willing  to  make 
two  canoes  for  two  of  his  fellow  islanders,  in 
return  for  their  building  the  additional  room  for 
him.  Then  we  could  say  that  the  value  of  the 
room  was  two  canoes  or  that  a  canoe  was  worth 
the  half  completed  room.  Crusoe,  alone  on  his 
island,  can  make  no  trade;  but  he  can  appraise 
the  room  in  terms  of  canoes  and  clothes  to  the 
extent  of  deciding  whether  he  will  produce  the 
one  or  the  other  two.  Similar  comparisons  would 
be  made  in  the  case  of  goods  satisfying  somewhat 
the  same  need.  For  a  quart  of  berries,  Crusoe 
might  be  willing  to  work  two  hours  and  for  a 
boiled  lobster  two  hours.     Then  the  lobster  would 


8  Earned  and  Unearned  Incomes. 

be  worth,  to  Crusoe,  two  quarts  of  berries.  Each 
article  can  be  compared  with  each  other,  directly 
or  through  the  common  means  of  purchasing  them 
all  from  nature,  viz.  labor.- 

We  have  now  to  take  into  consideration  another 
fact,  so  far  not  mentioned.  This  is  that  successive 
units  of  any  article  or  service  have  a  progressively 
lower  degree  of  utility.  Crusoe's  one  suit  of  goat 
skin,  if  he  can  afford  no  more,  will  have  great 
utility  to  him,  will  be,  in  fact,  indispensable.  A 
second  suit  will  be,  perhaps,  important  but  not  as 
much  so.  A  third  will  be  comparatively  unim- 
portant. Similarly,  a  one-room  shelter  will  be 
indispensable;  a  second  room  may  be  almost 
indispensable;  a  third  will  be  a  great  convenience, 
a  fourth  somewhat  convenient,  and  so  on.  It  is 
certain  that  Crusoe  will  get  himself  enough  food  to 
support  life,  if  he  possibly  can.  It  is  pretty  certain 
that  he  will  build  and  keep  in  some  repair  one  room. 
It  is  pretty  certain  that  he  will  keep  himself  sup- 
plied with  one  suit  of  clothes.  How  much  beyond 
these  essentials  he  will  go  will  depend  upon  his 
intensity  of  desire  for  comforts  and  luxuries  and 
also  upon  his  strength,  energy  and  willingness  to 
work. . 

Having  seen  that  the  utility  of  any  good  dimin- 
ishes for  Crusoe  according  as  he  has  a  large  amount 
of  that  good,  let  us  reexamine  our  conclusion  re- 
garding the  utility  to  him  of  a  room  as  compared 
with  that  of  a  canoe.  The  comparative  utilities  of 
these  two  items  of  wealth  will  depend  on  how 
much  room  Crusoe  already  has  as  well  as  upon  his 

2  Or  labor  and  waiting.     See  Chapters  III  and  IV. 


The  Determination  of  Value.  9 

need  for  room  in  general  or  for  a  canoe.  If  he 
has  no  room  at  all,  a  one-room  hut  will  probably 
seem  much  more  important  to  him  than  a  canoe, 
and,  rather  than  go  without  it,  he  might  be  willing 
to  do  much  more  work  than  he  would  do  for  a 
small  boat.  But  the  utility  of  a  second  room 
would  be  less  and  that  of  a  third  still  less.  Suppose 
Crusoe  would  as  soon  have  a  canoe  as  to  have  the 
third  room.  Then  he  would  be  willing  to  devote  as 
much  labor  to  getting  the  one  as  to  securing  the 
other.  If  the  time  necessary  to  build  an  additional 
room  is  four  weeks  and  that  necessary  to  make  a 
canoe  is  two  weeks,  he  would  choose  the  canoe  after 
he  had  a  sufficient  number  of  rooms  so  that  an 
additional  room  would  have  less  than  twice  the 
(marginal)  utility  of  a  canoe.  If,  that  is,  the  labor 
of  building  a  room  remains  always  twice  that  of 
making  a  canoe,  regardless  of  the  number  of 
rooms  added,  then  this  labor  cost  determines  the 
number  of  rooms  which  Crusoe  will  build  in 
preference  to  a  canoe  and,  therefore,  the  marginal 
utility  of  a  room,  (the  utility  of  the  last,  final  or 
marginal  room).  The  value  of  a  room  in  terms 
of  canoes  will  depend  upon  the  utility  of  an  ad- 
ditional room,  but  this  utility  will  depend  upon 
the  number  of  rooms  Crusoe  already  has  and  this, 
again,  will  depend  upon  the  labor  required  to 
build  a  room. 

But  suppose  that  the  nearby  available  material 
for  house  building  is  scarce,  that  additional  rooms 
necessitate  longer  trips  for  materials,  and,  perhaps, 
greater  search  to  find  materials  that  are  satis- 
factory,— in  other  words,  that  the  labor  of  con- 
structing  additional   rooms   becomes   progressively 


10  Earned  and  Unearned  Incomes. 

greater  as  more  rooms  are  built.  Then  the  labor 
of  construction  no  more  determines  the  utility  and 
value  of  a  room  than  its  utility  and  value  deter- 
mine the  amount  of  labor  which  Crusoe  will 
undergo  to  build  it.  For  if  the  utility  of  additional 
rooms  to  Crusoe  is  little,  he  will  construct  but  one 
or  two  rooms  and  the  labor  of  construction  will  be 
slight;  whereas,  if  the  utility  of  additional  rooms 
is  great,  he  will  build  them,  in  preference  to  a 
canoe,  until  the  labor  of  construction  (per  added 
room)  is  considerable.  Nevertheless  it  will  still 
be  true  that  when  the  utility  of  an  additional 
room  becomes  less  in  relation  to  the  labor  of  con- 
struction than  is  the  utility  of  a  canoe  in  relation 
to  the  labor  of  its  construction,  Crusoe  will 
cease  adding  rooms  and  will  turn  to  the  building 
of  a  canoe.  And  the  value  of  a  room  will  still  be 
measured  by  its  utility  in  relation  to  the  utility 
of  a  canoe,  or  by  the  labor  of  its  construction  in 
relation  to  the  labor  of  constructing  a  canoe. 
Either  method  of  measurement  is  correct  since 
either  is  equivalent"*  to  the  other. 


Conditions  Determiniiig  The  Extent  of  An  Isolated 

Man's  Production 

Having  considered  the  principles  determining 
the  relative  amounts  of  different  goods  that  an 
isolated  man  will  produce,  and  the  values  or  the 
comparative  utilities  of  these  goods,*  we  may  now 
profitably    give   brief   attention    to   the    considera- 

'  At   the   margin. 

*  See,  however,  the  further  considerations  in  Chapter  IV,  §  i. 


The  Determination  of  Value.  11 

tions  determining  the  total  amount  of  such  a  man's 
production.  Of  course  Crusoe  will  produce  neces- 
sary food.  It  is  scarcely  less  certain  that  he  will 
make  himself  some  clothing  and  get  at  least  a 
crude  kind  of  shelter.  His  different  wants  will 
receive  satisfaction  in  the  order  of  and  to  the 
extent  commensurate  with  their  importance  and 
the  ease  with  which  they  can  be  satisfied.  The 
wants  remaining  unsatisfied  will  be  of  progressive- 
ly less  importance  in  relation  to  the  effort  or  other 
sacrifice  necessary  to  satisfy  them.  On  the  other 
hand,  additional  hours  of  labor  per  day  soon  come 
to  involve  discomfort  and  sacrifice  to  an  increasing 
degree.  If  Crusoe  works  thirteen  hours,  he  will 
almost  certainly  find  the  thirteenth  hour  of  labor 
harder  than  the  tenth,  eleventh  or  twelfth.  He 
will  choose  to  work  eight,  ten,  twelve  or  thirteen 
hours  as  the  case  may  be,  according  to  the  relation 
between  the  utility  to  him  of  the  goods  which  the 
last  hour's  work  produces  and  the  disutility 
(discomfort  or  labor  sacrifice)  of  the  last  hour's 
work.  If  the  importance  to  him  of  the  goods 
which  his  tenth  hour  produces  is  more  than  enough 
to  compensate  him  for  the  work  done,  then  he  will 
work  ten  hours.  Or,  perhaps,  at  nine  hours  and 
three-quarters  the  last  minute's  work  just  balances 
in  sacrifice  the  gains  to  be  secured.  Then  it  will 
be  a  matter  of  indifference  to  him  whether  he 
works  nine  hours  and  forty-four  minutes  or  nine 
hours  and  forty-five  minutes,  but  he  will  not  work 
nine   hours   and   forty-six   minutes."* 

s  See  Jevons,    The    Theory   of  Political  Economy,   fourth   edition, 
p.  173. 


12  Earned  and  Unearned  Incomes. 

§   3 

Utility,    Relative    Production    of   Different    Goods, 
and  Value,  in  a  Modern  Community 

We  have  seen  how  an  isolated  man  compares 
the  utility  of  different  objects  and  what  considera- 
tions determine  the  amounts  of  them  that  he  will 
produce.  Let  us  now  consider  how  values  are 
determined  in  a  community  of  persons,  where 
there  is  division  of  labor  and  where,  therefore, 
exchange  of  goods  is  a  characteristic  feature  of 
economic  life.  In  general,  and  with  a  qualification 
which  will  be  made  shortly,*'  an  isolated  group  of 
producers,  or  an  entire  community  isolated  from 
other  communities,  or  society  as  a  whole,  produces 
to  a  larger  degree  those  things  of  which  its  mem- 
bers desire  large  amounts,  provided  the  sacrifice 
or  cost  of  production  is  no  greater,  and  produces 
to  a  less  extent  goods  not  so  much  desired.  Suppose, 
for  instance,  that  we  are  considering  a  community 
whose  members  desire  large  amounts  of  bread 
and,  therefore,  wheat,  but  only  a  small  quantity  of 
apples.  Then  large  amounts  of  wheat  will  be 
produced  and  not  many  apples.  But  since  the 
producers  of  wheat  and  of  apples  do  not  consume 
most  of  their  own  production,  their  relative  tastes 
and  preferences  as  between  these  two  kinds  of 
goods  can  not,  to  any  large  extent,  act  upon  them 
directly.  It  is  the  tastes  and  preferences  of  buyers 
which  affect  price  by  influencing  demand.  Thus 
the  large  general  demand  for  wheat  means  that 
there   are   many   persons   willing  to   pay   a   good 

*  See  second  and  third  paragraphs  after  this. 


The  Determination  of  Value.  13 

price  for  it  rather  than  not  to  have  it  or  rather 
than  to  have  less  of  it,  that  the  amounts  these 
persons  are  willing  to  purchase  can  only  be 
produced  by  the  labor  of  many  wheat  raisers,  and 
that  the  prices  which  the  consuming  purchasers 
are  willing  to  pay  are  such  as  will  make  many 
persons  willing  to  engage  in  (and  devote  their 
land  to)  wheat  production.  On  the  other  hand,  to 
say  that  apples  are  not  greatly  desired  is  to  say 
that,  unless  the  price  is  very  low,  there  are  few 
persons  who  want  any  or  that  those  who  want 
them  want  but  small  amounts,  or  both.  It  follows 
that  large  amounts  can  not  be  sold  at  a  remuner- 
ative price  and  that  the  price  consumers  will  pay 
is  only  high  enough  to  keep  a  comparatively  few 
producers  (and  few  acres)  in  apple  production, 
and  is  not  high  enough  to  tempt  larger  numbers 
into  it.  Of  course  if  the  apple  growers  do  not 
receive  almost  as  much  for  their  work  as  the  wheat 
raisers  they  may  not  consent,  even  in  small 
numbers,  to  continue  their  occupation  very  long. 
But  it  is  entirely  possible  that  there  will  be  a  few 
who  will  like  the  work  well  enough  to  remain  in 
it  even  if  their  return  is  very  slightly  less  than  it 
might  be  in  the  other  line  of  production.  There 
will  be  some,  also,  who,  while  earning,  perhaps, 
less  than  most  wheat  raisers,  remain  apple  growers 
because  they  are  not  well  adapted  for  wheat 
raising  and  would  make  even  smaller  returns  in  it. 
Similarly  some  land  will  be  devoted  to  apple 
growing,  even  with  a  low  price  of  apples  and  with 
consequent  small  returns  to  the  owner  of  the  land 
so  used,  because  the  land  will  produce  even 
smaller    returns    if    used    for    the    production    of 


14  Earned  and  Unearned  Incomes. 

wheat.  Furthermore,  if  there  has  been  produced 
in  the  community  in  question  a  certain  more  or 
less  necessary  quantity  of  wheat,  additional  amounts 
of  wheat  will  have  so  little  utility  that  apples  or 
other  goods  will  be  preferred.  The  conditions  of 
demand  and  value  will,  therefore,  encourage  a 
larger  production  of  wheat  than  of  apples  but 
not  a  production   entirely  devoted  to  wheat. 

Thus,  in  a  considerable  community,  demand  and 
the  conditions  of  production  determine  the  relative 
amounts  of  different  goods  which  are  produced. 
Variety  of  consumption  results  both  from  the  fact 
that  increasing  amounts  of  any  good  reduce  its 
marginal  utility  so  that  additional  amounts  are  less 
desired  than  other  things,  and  also  from  the  fact 
that  additional  amounts  of  any  kind  of  goods  may 
cost  more  by  requiring  producers  and  land  which, 
except  for  the  offering  of  a  high  price,  would  be 
devoted  to  another  line  of  production.'  And  as 
with  an  isolated  individual,  a  community  labors, 
through  the  activities  of  its  members,  to  produce 
goods  up  to  the  point  where  the  sacrifice  of 
production  is  just  balanced  by  the  satisfaction  or 
utility  or  the  anticipated  satisfaction  of  consump- 
tion. 

But  in  an  organized  community  of  the  modern 
industrial  type,  carrying  on  economic  activities 
with    a    considerable    degree    of    specialization    or 

"  The  United  States  government  has  recognized  this  principle, 
during  the  present  war,  by  guaranteeing  to  farnners  a  minimum 
price  of  wheat.  An  alternative  might  be  government  direction  of 
occupations  and  investment  by  way  of  compulsion.  A  man  might  be 
compelled  to  work  in  some  line  of  activity  for  a  less  return  than 
he  could  get  if  allowed  to  work  in  some  other  line- 


The  Determination  of  Value  15 

division  of  labor,  the  utility  of  any  goods  consumed, 
to  the  conmimer,  is  not  necessarily  or  even  probably 
just  equal  to  the  disutility  of  producing  them,  to 
the  jn'oducer.  For  in  such  a  community  each  person 
engaged  in  productive  activity  produces  goods  or 
services  which  others  enjoy/  The  labor  sacrifice  of 
the  producers  of  hats  may  or  may  not — probably 
will  not — be  the  exact  equivalent  of  the  enjoyment 
or  anticipated  enjoyment  of  the  wearers  of  the 
hats.  Thus,  the  hats  in  question  may  be  of  the 
variety  affected  by  the  well-to-do  for  formal 
evening  wear,  and  may  be,  therefore,  far  removed 
from  the  list  of  necessities.  The  utility  of  or  the 
satisfaction  yielded  by  these  hats  may  be  compar- 
atively slight,  but  they  are  purchased  because,  to 
their  purchasers,  the  utility  of  money  is  also 
comparatively  slight.  Yet  the  disutility  of  the 
last  hour's  work  in  making  them,  to  the  producers 
of  the  hats,  may  be  considerable,  far  more  than 
would  be  compensated  by  the  enjoyment  of  such  a 
luxury.  These  producers  may  be,  for  the  most 
part,  comparatively  poor,  so  that  the  payment  for 
the  last  hour  of  their  labor  represents  necessities 
rather  than  luxuries.  The  necessities  so  purchased 
by  them,  although  worth  no  more  in  the  market 
than  the  hats  which  they  have  produced,  have  to 
these  hat  makers  a  utility  corresponding  to  the 
labor  sacrifice  which  they  have  to  undergo  in 
earning  the  necessities.  Their  necessities  have, 
that  is,  a  utility  to  them  equal  to  the  disutility  of 
producing  the  hats.  But  the  hats  have  not,  to 
them,  any  such  utility. 

8Cf.   J.   B.   Clark,    D'istnhuUnn   of   Ifnilt/i,   New    York    (Macmll- 
lan),   1899,  p.  390. 


16  Earned  and  Unearned  Incomes 

On  the  other  hand,  the  wearers  of  the  hats  may 
be  engaged  in  producing  (or  capital  which  their 
earlier  efforts  and  saving  have  enabled  them  to 
accumulate  may  be  instrumental  in  producing) 
the  very  articles  of  necessity  which  the  hat 
producers  consume.  The  utility  of  these  articles, 
or  services,  to  those  who  consume  them  may  there- 
fore be  much  greater  than  the  disutility  (of  labor 
or  waiting^  or  both)  required  for  their  production 
by  the  classes  engaged  in  producing  them.^°  In 
modern  industrial  society,  then,  there  is  a  rough 
correspondence  between  the  utility  of  the  goods 
which  a  man  buys  with  the  proceeds  of  his  last 
hour  of  work,  and  the  disutility  of  the  work.  But 
we  cannot,  in  such  a  society  with  its  division  of 
labor,  its  strata  of  wealthy  and  poorer  classes, 
and  its  differences  of  individual  energy  and  taste, 
assert  any  very  marked  correspondence  between 
the  utility  of  goods  to  a  consumer  and  the  disutility 
of  labor  or  labor  and  waiting  undergone  by  a 
producer. 

§  4 

Demand  and  Supply  in  Relation  to  Price 

The  division  of  labor  characteristic  of  modern 
society  means  that  different  persons  produce 
different  things  for  a  market,  that  we  specialize  in 

"  See  Chapter  III,  §5,  for  a  brief  discussion  of  whether  waiting 
involves  a  disutility  in  the  sense  of  pain-cost. 

1"  We  are  here  assuming  that  all  the  classes  under  discussion  and 
enjoying  incomes,  contribute  something  to  production.  Neverthe- 
less, there  are  classes,  as  we  shall  later  see,  which  reap  where  they 
have  not  sown. 


The  Determination  of  Value.  17 

production  and  then  trade  to  get  what  as  in- 
dividuals or  family  groups  we  want.  The  problem 
of  value  in  such  a  society  is  the  problem  of 
explaining  what  factors  determine  the  ratios  of 
exchange  between  different  kinds  of  goods.  The 
explanation  of  the  problem  begins  with  a  study  of 
demand  and  supply.  The  price  of  any  article  is 
determined,  by  the  competitive  forces  of  business, 
at  that  point  which  equalizes  demand  and  supply. 
As  has  been  frequently  pointed  out,  demand  must 
be  distinguished  from  mere  desire  and  supply 
must  be  distinguished  from  stock.  There  may  be 
many  persons  who  desire  automobiles,  but  whose 
desires  are  of  no  significance  economically  because 
not  backed  by  any  financial  ability  to  purchase. 
Demand  implies  ability  to  buy  as  well  as  desire 
to  buy.  Furthermore,  since  the  amount  which 
would  be  purchased  by  buyers  depends  partly  on 
price,  demand  should  be  stated  in  relation  to  some 
price.  We  should  therefore  say,  in  defining  de- 
mand :  the  demand  for  any  kind  of  goods,  e.  g. 
cotton  cloth,  at  any  given  price  (per  yard)  is  the 
amount  (number  of  yards)  of  those  goods  which 
purchasers  would  take  at  that  price. 

It  is  a  generally  recognized  fact  that  demand  is 
greater,  other  things  equal,  when  price  is  lower, 
and  that  demand  is  less  when  price  is  higher. >^ 
Assuming  other  things  equal,  we  can  suppose  a 
complete  schedule  of  demands,  corresponding  to  all 
possible  prices.    All  but  one  of  these  demands  are 

11  The  case  of  goods  purchased  for  display  is  probably  not  an  ex- 
ception since,  first,  a  reduction  of  price  simply  means  that  the  same 
display  requires  a  larger  purchase  and,  second,  a  reduction  of  price 
may  make  possible  some  display  by  a  lower  economic  group. 


18  Earned  and  Unearned  Incomes. 

hypothetical,  since  they  correspond  to  prices  that 
do  not  exist.  They  are,  in  each  case,  what  the 
demand  icould  be  if  the  price  of  the  goods  were 
thus  and  so.  The  demand  corresponding  to  the 
actual  price,  represents  an  actual  demand.  But 
the  other  demands,  especially  those  corresponding 
to  prices  near  the  actual  price,  are  important, 
because  they  stand  for  forces  of  competition 
which  help  to  determine  actual  price.  If  the  price 
should  go  lower,  demand  would  increase  and  might 
exceed  supply,  thus  bringing  price  back  again  to 
the  point  of  equilibrium.  We  must,  therefore, 
recognize  a  series  of  potential  demands  corre- 
sponding to  a  series  of  hypothetical  prices;  yet  we 
must,  also,  recognize  that  the  actual  demand  for 
any  article  is  the  one  which  goes  with  the  actual 
price  or  prices  of  that  article  during  the  period  in 
question. 

Supply,  also,  needs  to  be  carefully  defined.  The 
total  stock,  say  of  cotton,  in  existence  at  any  time, 
is  not  the  supply  in  the  sense  here  used.  Supply, 
like  demand,  should  be  spoken  of  in  connection 
with  price.  The  supply  of  any  kind  of  goods,  at 
any  given  price,  is  the  amount  which  sellers  would 
dispose  of  at  that  price.  At  a  higher  price,  more 
persons  would  be  encouraged  to  produce  the  goods 
for  sale,  and  those  already  producing  them  would 
be  inclined  to  produce  more.  At  a  lower  price 
there  would  be  less  encouragement  to  the  production 
of  the  goods.  Even  if  we  are  dealing  only  with 
temporary  or  short-run  supply,  e.  g.  the  supply  of 
corn  in  April,  so  that  a  rise  of  prices  could  not 
for  several  months  increase  the  amount  ^produced, 
it   might  still  be  true  that   a   higher  price   would 


The  Determination  of  Value.  19 

tend  towards  a  greater  supply  and  vice  versa. 
For  at  a  price  much  below  normal,  many  who 
otherwise  might  sell  their  corn,  would  be  inclined 
to  hold  it  in  the  hope  of  a  higher  future  price. 
As  in  the  case  of  demand,  we  may  have  a  supply 
schedule  with  a  supply  corresponding  to  each 
assumed  price;  and  each  such  supply  is  hypothet- 
ical except  the  supply  which  corresponds  to  the 
actual  price.  But  the  hypothetical  supplies  are 
not  to  be  ignored  since  consideration  of  them 
enables  us  better  to  understand  the  nature  of  the 
competitive  conditions  by  which  price  is  fixed. 

Both  demand  and  supply  operate  only  during  a 
period  of  time.  This  period  of  time  may  be  longer 
or  shorter  according  as  the  problem  which  in- 
terests us  is  long-run  or  short-run  price.  If  we 
are  considering  the  determination  of  so-called 
market  price,  cur  concern  is  with  demand  and 
supply  during  a  brief  period,  e.  g.  a  week,  a  day, 
or  an  hour.  If  we  are  considering  the  determina- 
tion of  seasonal  price,  say  of  corn  or  cotton,  our 
concern  is  with  demand  and  supply  between  one 
harvest  and  the  next.  If  we  are  considering,  for  a 
certain  manufactured  good,  the  determination  of 
the  price  corresponding  in  some  degree  to  the 
seasonal  price  of  an  agricultural  product,  our 
concern  is  with  demand  and  supply  of  this  good 
during  a  period  so  short  that  additional  plants  for 
the  manufacture  of  the  good  could  not  be  con- 
structed and  so  short  that  existing  factories  and 
machinery  would  not  wear  out.'-     During  such   a 

■^^  Cf.  Taussig,  Pinciples  of  Economics,  second  edition,  New  York 
(Macmillan),  1915,  Vol.  i,  pp.  149,  150. 


20         Earned  and  Unearned  Incomes. 

period  the  good  in  question  might  be  continuously 
produced,  but  the  amount  produced  could  not 
much  exceed,  though  it  might  fall  short  of,  the 
normal  capacity  of  the  plants.  Finally,  if  we  are 
considering  long-run  or  normal  price,  our  concern 
is  with  demand  and  supply  over  a  longer  period 
involving  a  number  of  seasons  or,  in  the  case  of  a 
manufactured  good  produced  with  large  plant, 
involving  a  sufficient  number  of  years  so  that  the 
cost  of  construction  of  plants  becomes  an  im- 
portant influence  on  the  supply  of  the  articles 
produced  by  such  plants. 

It  has  been  said  above  that  the  higher  the  price 
of  a  good,  the  larger  (other  things  equal)  will  be 
the  amount  supplied,  and  the  less  will  be  the 
amount  demanded.  A  high  price,  therefore,  seems 
to  be  associated  with  a  large  supply  and  a  low 
price  with  a  large  demand.  This  may  appear  to 
be  contrary  to  the  commonly  accepted  notion  that 
high  price  means  shortage  of  supply,  or  unusually 
large  demand,  or  both.  Yet  in  truth  there  is  no 
inconsistency  in  the  statement  of  these  apparently 
opposite  relationships.  The  phenomena  in  question 
involve  an  interaction  of  cause  and  effect.  The 
prospect  of  being  able  to  receive  a  high  price  for 
goods  certainly  stimulates  the  production  of  those 
goods.  Yet  a  large  production  tends  to  force 
down  the  price.  So,  also,  in  the  case  of  demand,  it 
is  certainly  true  that  low  prices  of  goods  encourage 
purchases,  and  it  is  likewise  true  that  large  pur- 
chases tend  to  make  prices  high. 

Our  present  task  is  to  examine  the  exact  way  in 
which  the  forces  on  the  demand  and  on  the  supply 
side  of  the  market  operate  to  determine  price.    The 


The  Determination  of  Value.  21 

price  of  any  kind  of  goods  tends  always  to  be 
fixed  at  that  point  where  demand  and  supply  are 
equal.  To  demonstrate  this  tendency,  let  us  assume 
prices  at  which  demand  and  supply  are  not  equal 
and  show  that  such  prices  involve  unstable  equilib- 
rium and  hence  can  not  continue.  We  may  sup- 
pose that,  in  a  given  market,  a  price  of  8  cents 
a  pound  for  cotton  would  equalize  demand  and 
supply  and  that,  at  such  a  price,  both  the  demand 
and  the  supply  would  be  10,000,000  pounds.  At 
7  cents,  the  demand  would  be  greater,  say  for 
11,000,000  pounds,  while  the  supply  would  be  less, 
perhaps  9,000,000  pounds.  Why,  nevertheless, 
might  not  7  cents  be  the  resulting  price?  The 
answer  is  to  be  found,  not  in  a  mere  statement 
that  demand  then  would  exceed  supply,  but  in  an 
analysis  of  the  conditions  and  forces  of  the  market, 
for  which  the  terms  demand  and  supply  are  merely 
our  mode  of  expression.  Since,  at  a  price  of  7 
cents,  there  are  prospective  buyers  whose  total 
purchases  would  aggregate  11,000,000  pounds, 
while,  at  that  price,  only  9,000,000  pounds  would 
be  forthcoming,  not  all  of  the  prospective  buyers 
willing  to  purchase  at  7  cents,  could  get  the  de- 
sired amounts  of  cotton.  Many  of  them  would  bid 
more  than  7  cents  rather  than  not  get  the  cotton 
wanted  and  this  bidding  would  force  the  price  up. 
Any  price  lower  than  8  cents  would  leave  a  pre- 
ponderance of  force  on  the  demand  side  of  the 
market,  and  would  involve  a  further  competitive 
bidding  up  of  price.  But  we  could  not  expect  to  have 
a  bidding  up  of  the  price  beyond  8  cents.  For  at  8 
cents  the  supply  is  equal  to  the  demand.  In  other 
words,  all  those  who  are  willing  to  pay  8  cents  a 


22  Earned  and  Unearned  Incomes. 

pound  can  get  all  the  cotton  which,  at  that  price, 
they  are  willing  to  buy.  No  one  of  them  has 
occasion  to  offer  a  higher  price  to  insure  his 
getting  the  desired  amount  of  cotton.  If  any  one 
of  them,  for  any  reason,  chooses  to  offer  and  pay 
a  higher  price,  other  purchasers  need  not  do  so. 
For,  by  hypothesis,  the  supply  at  8  cents  a  pound 
is  enough  to  satisfy  the  demand.  Hence,  even 
after  the  purchases  of  any  who  for  any  reason  pay 
more  are  completed,  there  will  still  be  enough 
purchasable  at  8  cents  to  satisfy  the  remainder  of 
the  demand.  We  see,  then,  that  the  conditions  and 
forces  of  a  market  will  not  permit  the  continuance 
of  a  price  below  that  which  equalizes  demand  and 
supply,  but  that  there  is  no  reason  why  intending 
purchasers  should  pay  more  than  this  equalizing 
price. 

Let  us  now  suppose  a  price  above  that  which 
equalizes  demand  and  supply,  in  order  to  see 
clearly  that  such  a  price,  also,  could  not  continue. 
At  a  price  of  (say)  9  cents  a  pound,  the  demand 
for  cotton  might  aggregate  not  over  8,000,000 
pounds ;  while  the  supply  would  be  more  than  at  a 
price  of  8  cents  and  might  aggregate  11,000,000 
pounds.  Obviously,  the  11,000,000  pounds  which 
sellers  might  be  willing  to  supply  at  a  price  of  9 
cents  a  pound,  could  not  be  entirely  disposed  of  at 
a  price  of  9  cents.  Unless  the  price  falls,  some 
who  are  willing  to  sell  for  less  than  9  cents  rather 
than  not  sell,  will  be  left  with  cotton  on  their 
hands.  These  will  bid  against  each  other  in  order 
to  dispose  of  their  cotton,  and  this  bidding  will 
lower  the  price  to  8  cents.  But  it  will  not  lower 
the  price   more  than   that,   for  all   those  who  are 


The  Determination  of  Value.  23 

willing  to  sell  at  8  cents  a  pound  can  find  pur- 
chasers. Should  any  sellers  choose,  for  some  un- 
accountable reason,  to  dispose  of  their  cotton  at 
a  lower  price,  nevertheless  others  would  not  have 
to  do  likewise ;  for  the  cotton  supplied  by  these 
others  at  8  cents  a  pound  would  be  necessary  to 
satisfy  the  demand  and  would,  therefore,  at  this 
price,  be  purchased.  We  conclude  that  price  is 
fixed,  by  market  conditions,  at  a  point  such  as  to 
equalize  demand  and  supply,  since  for  price  to  be 
fixed  at  any  other  point  involves  a  condition  of 
unstable    equilibrium. 

§   5 

Explanations   and   Qualifications 

It  is  frequently  stated  that,  assuming  perfect 
competition,  there  can  be  but  one  price  for  a 
given  kind  of  goods,  in  any  market  and  at  any  one 
time.  Thus,  some  men  would  not  be  selling  cotton 
in  a  market  at  7  cents  a  pound  at  the  same  time 
that  others  were  selling  for  8  cents.  For,  if  the 
dealers  asking  7  cents  could  completely  satisfy 
the  demand,  those  asking  8  cents  would  make  no 
sales;  while  if  those  selling  at  7  cents  could  not 
completely  satisfy  the  demand,  they  would  soon 
realize  that  a  higher  price  could  be  asked.  By  a 
similar  line  of  reasoning  we  may  conclude  that, 
if  some  purchasers  were  paying  8  cents  and  others 
only  7  cents,  those  having  cotton  to  sell  would 
sell  it  by  preference  to  the  former.  If  the  pur- 
chasers at  8  cents  could  take  the  entire  supply, 
those  willing  to  pay  but  7  cents  would  get  no 
cotton,  while,  if  the  purchasers  at  8  cents  could  not 


24  Earned  and  Unearned  Incomes. 

take  the  entire  supply,  they  would  soon  realize  that 
they  could  get  what  cotton  they  wanted  without 
offering  so  high  a  price. 

When  it  is  said,  then,  that  perfect  competition 
makes  impossible  more  than  one  price  for  any 
kind  of  goods  in  a  given  market  at  any  given  time, 
perfect  competition  must  be  understood  to  mean 
complete  knowledge  on  the  part  of  all  the  buyers 
and  sellers,  of  conditions  throughout  the  market, 
a  readiness  on  the  part  of  each  buyer  to  buy  where 
he  can  buy  most  cheaply,  and  a  corresponding  en- 
deavor on  the  part  of  each  seller  to  sell  to  whoever 
will  pay  the  most.  So  far  as  knowledge  is  in- 
complete, or  so  far  as  buyers  and  sellers  are 
actuated  by  motives  not  purely  economic  (e.  g.  by 
the  motive  of  friendship),  there  is  the  possibility 
of  two  or  more  prices  existing  side  by  side  in  the 
same  market.  On  the  exchanges,  where  goods  are 
bought  and  sold  in  such  large  quantities  as  to 
make  the  effort  for  complete  information  clearly 
worth  while,  there  is  seldom  any  great  difference 
in  price  among  different  transactions  in  any  one 
kind  of  goods,  taking  place  at  the  same  time.  In 
retail  trade,  where  the  purchases  of  any  individual 
from  day  to  day  are  so  small  that  it  sometimes 
seems  scarcely  worth  the  trouble  to  investigate 
slight  differences  in  price  or  to  go  much  farther 
than  the  nearest  store,  differences  in  price  are 
more  likely  to  arise  or  to  persist. 

Besides  the  possibility — and,  in  some  cases, 
probability — of  differences  in  the  price  of  a  kind  of 
goods  at  any  given  time,  there  is  also  to  be  con- 
sidered the  likelihood — almost  the  certainty — that 
price  will   fluctuate   from   month   to  month,   from 


The  Determination  of  Value.  25 

week  to  week,  from  day  to  day,  even  from  moment 
to  moment.  But  some  length  of  time  is  required 
for  the  carrying  out  of  any  transactions  whatever. 
Demand  and  supply,  therefore,  almost  necessarily 
have  reference  to  a  period  of  time  rather  than  to 
an  instant/^  It  follows  that,  except  as  we  imagine 
a  period  of  time  infinitesimally  brief,  we  cannot 
say  with  complete  accuracy  that  demand  and  sup- 
ply are  equalized  by  any  one  price.  Demand  for 
and  supply  of  wheat,  during  a  year,  are  equalized 
by  a  series  of  changing  prices  from  day  to  day 
during  the  year,  or  by  an  average  price.  Either 
the  seasonal  price,  or  the  long  run  or  normal  price 
is,  then,  an  average  of  prices,  an  average  of  a  se- 
ries of  prices  differing  somewhat  from  each  other. 
Even  the  market  price  has  reference  rather  to  a 
very  short  period  than  to  a  point  of  time. 

It  is  often  said,  in  explanation  of  a  rise  in  the 
price  of  some  commodity,  that  the  demand  for  it 
has  increased  or  that  the  supply  has  decreased; 
and  in  explanation  of  a  fall  in  price  it  is  commonly 
stated  that  the  demand  has  decreased  or  the  supply 
increased.  Obviously,  an  increased  demand,  say 
for  cotton,  which  raises  its  price,  is  different  from 
an  increased  demand  which  merely  results  from  a 
fall  of  price.  When  we  say  that  an  increase  of  de- 
mand has  raised  the  price  of  cotton,  we  mean  that 
the    potential    demand    at    each    possible    price    is 

13  Though  we  might  define  them  as  the  amounts  which,  at  any 
given  instant,  persons  stand  ready  to  buy  and  sell  dtirin^^  some 
period.  This  would  not  help  us  any  and  would,  indeed,  be  subject 
to  the  objection  that  what  buyers  and  sellers,  at  any  given  moment, 
think  they  will  do  if  prices  remain  unchanged,  may  not  be  at  all 
what,  even  if  prices  so  remained,  they  actually  would  do. 


26  Earned  and  Unearned  Incomes. 

greater  than  previously  at  the  same  price.  In 
other  words,  the  whole  demand  schedule  has  shift- 
ed." Population  may  have  increased  or  new  uses 
may  have  been  discovered  for  cotton  or  tastes  and 
styles  may  have  changed,  so  that  cotton  goods  are 
more  desired  than  formerly.  Unless,  therefore, 
price  is  higher,  demand  will  exceed  supply,  buyers 
will  bid  against  each  other,  and  price  will  have  to 
rise. 

Likewise,  if  it  is  said  that  the  price  of  cotton 
rises  because  of  a  decreased  supply,  this  must  be 
held  to  mean,  not  that  there  is  a  decreased  supply 
consequent  on  a  lower  price,  but  that  there  is,  at 
each  assumed  price,  a  less  potential  supply  than 
formerly  would  have  been  forthcoming  at  that 
price.  This  fact  might  be  the  result  of  soil  ex- 
haustion or  of  a  possibility  of  using  land  more 
profitably  for  some  other  crop  or  (as  for  a  single 
season)  of  destruction  of  part  of  the  crop  by  the 
boll  weevil.  In  any  of  these  cases  demand,  at  the 
former  price,  would  exceed  supply,  and,  therefore, 
a  higher  price  must  result. 

Consider  now  the  conditions  which  make  for  a 
fall  in  price.  The  increase  of  supply  which  may 
cause  such  a  fall  is  not  the  increase  which  results 
from  a  larger  demand  and  a  higher  price,  but  is 
an  increase  of  supply  due  to  other  conditions  than 
a  rise  of  price.  It  may  be  due  to  improved  meth- 
ods of  cultivation  or  (as  for  a  single  season)  to 
exceptionally  favorable  weather  conditions.  Un- 
less the  price  falls,  there  will  then  be  an  excess  of 

'^See    Fisher,    Elementary    Principles    of    Economics,    New    York 
(Macmillan),   1912,  pp-  268-273. 


The  Determination  of  Value.  27 

supply  over  demand.  Sellers  of  the  cotton  there- 
fore bid  against  each  other  in  price  reduction,  caus- 
ing the  price  to  be  fixed  at  a  point  such  that  the 
demand  will  be  equal  to  the  now  larger  supply. 

But  price  may  be  lowered,  also,  through  a  de- 
creased demand.  This  decreased  demand  must  be 
supposed  to  be  a  demand  smaller  at  each  price 
and  not  a  smaller  demand  consequent  merely 
on  a  higher  price.  It  may  result  from  change 
of  taste  or  style  or  from  inability  of  part  of  the 
buyers,  owing  to  changed  conditions  diminishing 
their  prosperity,  to  make  their  desires  effective 
in  demand.  In  any  such  case  only  a  lower  price 
can  equalize  demand  and   supply. 

The  case  of  monopoly  price  is  not  altogether  ex- 
ceptional. Monopoly  price,  also,  is  fixed  where 
demand  and  supply  are  equal.  But  the  monopolist 
controls  the  supply  of  his  product  and  can  there- 
fore ordinarily  fix  his  price  so  as  to  secure  a  larger 
net  profit  than  would  be  possible  if  competition  had 
to  be  met.  But  if,  in  any  industry,  monopoly  seems 
inevitable  or  socially  preferable,  government  may 
regulate  the  price  or  prices  in  question.  Such 
regulation,  if  effective,  will  remove  the  motive  to 
limitation  of  supply.  The  regulated  monopoly  will 
rather  prefer  to  extend  its  business,  as  the  only 
way  of  making  a  considerable  profit.  To  regulate 
any  price  to  a  lower  point  than  gives  a  normal 
competitive  return  to  the  factors  engaged  in  the 
production  of  the  good  will  cause  these  factors  to 
be  shifted,  in  part,  to  other  lines  of  production. i'- 

^^  Oi  course  this  does  not  mean  that  wlien  the  government,  under 
its  war  power,  limits  a  grocer's  charge  for  sugar,  the  grocer  will 
change  his  business.     Even   if  tlie  limitation  were  known  to  be   for 


28  Earned  and  Unearned  Incomes. 

If  such  a  law  is  not  evaded,  it  can  only  be  because 
its  penalties  or  other  causes  bring  about  an  ap- 
preciable curtailment  of  demand  for  the  good  the 
price  of  which  is  regulated.  But  to  regulate 
monopoly  price  down  to  a  level  of  competitive 
profits,  will  tend  rather  to  increase  supply  than  to 
decrease  it. 

§   6 

Speculation  in  Relation  to  Price 

It  has  been  above  pointed  out^''  that  the  price  of 
any  kind  of  goods  may  fluctuate  from  week  to  week 
or  from  month  to  month.  This  fluctuation  is,  how- 
ever, limited  in  extent  by  the  activities  of  specula- 
tors, at  least  when  speculation  is  intelligently 
carrried  on.  We  might  be  inclined  to  expect  that 
the  price  of  (say)  wheat  would  be  very  low  im- 
mediately after  harvest,  because  of  the  large  quan- 
tity suddenly  thrown  on  the  market,  that  this 
lowness  of  price  would  discourage  its  production, 
and   that   its   scarcity,   realized   particularly   when 

a  long  period,  he  might  yet  remain  in  the  business  because  expecting 
a  substantial  profit  from  his  sales  of  other  groceries.  Nor  is  there 
any  intention  to  deny  that,  by  means  of  regulation,  priorities,  appeals 
and  otherwise,  government  may  decrease  the  consumption  of  and 
the  demand  for  many  goods  by  civilians  in  war  time,  thus  in  effect 
compelling  them  to  lend  it  their  funds  for  its  purposes,  for  lack  of 
the  customary  alternative.  But  if  government  expends  these  funds 
there  is  not  likely  to  be  a  reduction  in  average  prices.  (See  §7  of 
this  Chapter).  Permanently  to  regulate  everyone's  consumption  of 
goods  of  every  kind  (assuming  such  regulation  to  be  possible)  would 
amount  to  doing  away  with  the  competitive  money  system,  for  few 
would  bother  to  acquire  funds  which  they  might  not  expend. 
1°  In  the  immediately  preceding  section  (§5)  of  this  Chapter. 


The  Determination  of  Value.  29 

each  season's  stock  was  nearly  gone,  would  cause 
its  price  then  to  be  very  high.  But  speculators 
see  chances  to  make  profit  from  such  differences 
of  price.  They,  therefore,  buy  up  the  wheat  in 
the  fall,  when  its  price  is  low,  and  hold  it  for  sale 
at  a  time  when  a  greater  relative  need  makes  its 
price  higher.  The  large  purchases  in  the  fall  tend 
to  keep  the  price  of  wheat  from  going  as  low  as 
it  otherwise  might,  and  the  holding  of  a  con- 
siderable stock  into  the  spring  for  sale  then,  tends 
to  prevent  so  great  a  rise  as  might  otherwise  occur. 
Speculative  holding,  in  other  words,  increases  the 
demand  when  price  is  low  and  increases  the  supply 
when  price  is  high.  The  difference  between  the 
low  and  high  prices  will  therefore,  perhaps,  on 
the  average,  about  pay  for  the  skill,  trouble  and 
capital  furnished  by  the  speculator.  It  is  doubtless 
true  that,  in  the  absence  of  a  speculating  class, 
many  farmers  would  themselves  be  inclined  to  hold 
their  wheat  till  the  season  of  highest  price,  but 
many  others  find  this  inconvenient  and  risky.  The 
existence  of  a  class  of  speculative  buyers  enables 
the  farmers  to  sell  at  once  for  somewhere  near  the 
later  and  (on  the  average)  higher  price,  and  to 
avoid  risk  of  loss.  It  is  likely,  therefore,  to  en- 
courage wheat  production  and  thus  to  tend  towards 
a  reasonably  low  average  price  to  the  public. 
Purchase  in  the  fall  and  holding  by  millers  might, 
of  course,  serve  in  considerable  degree  the  same 
purpose.  But  this  would  compel  millers  to  be 
speculators  and  to  invest  large  capital  in  the 
storage  of  wheat,  and  it  is  not  certain  that  they 
would  perform  these  services  as  cheaply  as  special- 
ists. 


30  Earned  and  Unearned  Incomes. 

Consider  now  another  type  of  speculation.  The 
speculator  who  "sells  short"  really  promises  to  sell 
at  a  fixed  future  date  and  at  an  agreed  price,  goods 
which  he  does  not  possess  at  the  time  of  making 
the  promise.  The  buyer,  of  course,  undertakes,  on 
his  part,  to  purchase  the  goods  in  question  on  the 
agreed  date  and  at  the  agreed  price.  He  is  said  to 
buy  a  "future."  The  buyer  may  be  a  manufacturer 
or  a  dealer  to  whom  it  is  important  that  he  shall 
know  in  advance  just  what  certain  supplies  will 
cost  when  he  is  ready  for  them.  He  wishes  to 
avoid  any  risk  of  fluctuation  in  the  prices  of  these 
supplies.  The  speculator  assumes  this  risk  for 
him.  Thus,  a  speculator  may  agree,  in  April,  to 
sell  wheat  in  June  at  $1.90  a  bushel.  The  specu- 
lator should  be  an  expert  in  predicting,  so  that  to 
him  the  risk  from  possible  fluctuations  is  less  than 
it  would  be  to  others. ^^  But  even  to  the  specialist 
there  is  some  element  of  risk.  The  market  price 
when  June  arrives  may  be  $1.95.  In  that  case  the 
speculator  is  obliged  to  buy  for  $1.95  a  bushel  the 
wheat  which  he  has  agreed  to  sell  for  $1.90,^*  and 
loses  $0.05  on  each  bushel.  If  the  price  turns  out 
to  be  $1.87,  however,  he  gains  $0.03  on  each 
bushel  delivered.     The  fact  that  there  are  experts 

1'^  As  Fisher  has  well  pointed  out,  risk  is  fundamentally  a  matter 
of  ignorance.  Events  occur  only  when  their  causes  occur;  and  if 
we  could  know  all  the  relations  of  cause  and  effect  even  in  their 
most  intricate  ramifications  and  make  ourselves  familiar  with  ex- 
isting conditions,  we  could  predict  all  events  with  certainty.  Our 
uncertainty  is  due  to  no  inconsistency  of  Nature  but  to  an  ignorance 
of  Nature  that  makes  consistency  sometimes  appear  to  us  like  Incon- 
sistency. See  Fisher,  The  Nature  of  Capital  and  Income,  New 
York  (Macmillan),  1906,  pp.  265-269. 

i**  Or  pay  5c  a  bushel  to  the  man  with  whom  he  made  the  contract. 


The  Determination  of  Value.  31 

who  will  promise,  in  advance,  to  sell  at  an  agreed 
price,  probably  has  some  tendency  to  equalize 
prices.  For  if  scarcity  is  feared,  each  intending 
purchaser  (e.g.  miller)  would  be  likely  to  buy  in 
advance  and  hold  for  his  own  future  use  a  stock 
much  larger  than  would  satisfy  his  immediate 
needs.  Such  panic  buying  might  make  supply 
seem  relatively  short  (say  of  wheat  in  the  spring) 
and  cause  prices  to  rise  unduly.  But  instead  of 
thus  purchasing  in  advance  a  large  stock  of  the 
goods  they  desire,  prospective  users  can  arrange 
with  speculators  to  be  supplied  with  the  desired 
goods  as  these  goods  are  needed. 

It  is,  of  course,  the  intelligent  speculation  of 
experts  which  thus  tends  over  a  period  of  con- 
siderable length  to  equalize  prices.  So  far  as  the 
untrained  public  are  lured  into  speculative  use  of 
funds  by  the  prospect  of  large  chance  gains,  the 
effect  of  their  speculation  is  quite  as  likely  to  be 
greater  price  fluctuations  as  less.  For  the  untrain- 
ed public  are  not  unlikely  to  buy  when  prices  are 
high,  and  to  sell  in  a  panic  when  prices  are  low 
thus  causing  them  to  go  still  lower.  In  short 
selling,  also,  they  are  as  likely  as  not  to  make  cor- 
responding errors  of  judgment. 

§   7 

The  Determination  of  the  General  Level  of  Prices 

Let  us  now  apply  the  principles  of  demand  and 
supply  to  the  general  level  of  prices.  We  shall 
see  that  much  the  same  kinds  of  competitive  forces 
which  fix  any  one  price  (as  above  explained)  in 
relation   to   other  prices,   fix   the   general   level   of 


32         Earned  and  Unearned  Incomes 

prices  of  goods  in  terms  of  money.  We  shall 
consider  the  supply  of  goods,  including  the  services 
of  labor  and  of  "waiting"  (i.  e.  investing,  or 
putting  capital  into  use,  the  service  for  which 
interest  is  paid)  offered  for  money,  and  the  demand 
for  goods  by  those  having  money  to  spend. 

Where  there  is  only  fiat  (inconvertible  paper) 
money,  the  supply  of  goods  in  general,  offered 
for  money,  at  any  level  of  average  prices  of  those 
goods,  would  be  just  the  same  as  at  any  other 
level  of  prices.  This  is  very  nearly  true  no 
matter  what  the  money  system. ^^  If  wheat  prices 
are  higher  than  com  prices,  or  vice  versa, 
productive  effort  may  be  diverted  from  one  line 
into  another.  But  we  are  now  not  discussing 
changes  in  individual  or  relative  prices.  We  are 
discussing  only  changes  in  the  general  level  of 
prices,  the  average  of  prices.  If  the  general  level 
of  prices  should  double,  there  is  no  reason  to 
believe  that  the  amount  of  goods  produced  for 
sale  would  on  that  account  greatly  increase. 
Supposing  a  community  to  be  in  reasonable 
prosperity  and  business  activity  at  the  lower  prices, 
an  increase  of  these  prices  would  not  make  possible 
a  very  greatly  increased  production.  It  would 
not  enable  men  to  work  longer  hours  nor  would  it 
make  machinery  more  efficient.  Neither  would  it 
stimulate  the  sales  of  goods  by  making  such  sales 
more  profitable,  since  a  general  rise  of  prices 
simply  means  that  money  has  a  less  value.  If 
everything  should  sell  for  twice  as  much  money 
as  before,  the  sellers  would  gain  nothing,  for  the 

^^  See  remainder  of  this  section  for  explanation  of  why  it  Is  not 
always  entirely  true. 


The  Determination  of  Value  33 

things  they  desire  to  buy  would  also  cost  twice  as 
much.  Looking  at  the  matter  from  any  reasonable 
point  of  view,  it  must  be  admitted  that  the  supply 
of  goods  in  general,  at  a  higher  level  of  prices, 
would  be  no  greater  (or  but  slightly  greater)  ^^ 
than  at  a  lower  level.  Likewise,  at  a  lower  level  of 
prices,  the  supply  of  goods  would  be  no  less  than 
at  a  higher  one.  A  lower  level  of  prices  would  not 
mean  less  activity  or  a  smaller  sale  of  goods.  It 
would  pay  as  well  to  sell  goods  at  a  low  level  of 
prices  as  at  a  high  level,  since  at  the  lower  level 
the  money  received  would  have  correspondingly 
greater  purchasing  power. 

The  lower  level  of  prices  would  only  decrease 
the  supply  of  other  goods  and  the  higher  level 
increase  it,  in  one  contingency,  and  then  only  to  a 
very  limited  degree.  When  the  currency  system  is 
based  on  a  precious  metal,  e.  g.  gold,  a  lower  level 
of  prices  means  a  higher  value  of  gold  as  money. 
It  might  therefore  divert  some  labor  from  the 
production  of  other  goods  to  the  production  of 
gold  for  coinage.  A  higher  level  of  prices  might 
tend,  in  the  same  degree,  to  divert  labor  from 
gold  production  towards  the  production  of  other 
goods.  To  this  extent  only,  a  higher  level  of 
prices  would  tend  to  increase  the  supply  of  goods 
in  general  other  than  money,  and  a  lower  level  of 
prices  to  decrease  it. 

On  the  other  hand,  a  higher  level  of  prices  of 
goods  would  tend  to  decrease  the  demand  for  goods 
by  persons  having  money  to  spend.  For  with 
higher  prices,  and  no  greater  amount  of  money  to 

20  See  next  paragraph. 


34  Earned  and  Unearned  Incomes 

spend,  buj^ers  of  goods  would  be  unable  to  purchase 
as  much  as  at  lower  prices.  Lower  prices  of  goods 
would  mean  that  the  money  of  purchasers  would  go 
farther. 

Let  us  now  suppose  a  doubling  of  the  amount  of 
money.  Prices  would  tend  to  increase  in  nearly 
the  same  proportion.  Suppose  prices  did  not  rise. 
Then  purchasers  of  goods  would  buy  all  they  were 
in  the  habit  of  buying  and  still  have  as  much 
money  left  to  spend  as  they  formerly  spent  all 
together.  This  they  would  endeavor  to  spend  at 
once.  For  in  modern  countries  money  is  not 
hoarded  away,  but  only  enough  is  kept  on  hand 
for  emergency  requirements,  and  the  rest  is  spent. 
Those  who  save  are  spending  just  as  effectually 
as  any  others.  The  difference  is  in  what  they 
buy.  Those  who  save  buy  factories,  warehouses, 
railroads,  farms,  etc.  Even  though  their  savings 
are  put  into  a  savings  bank,  they  are  none  the 
less  spent  for  investment  goods.  It  follows  that 
a  sudden  doubling  of  the  amount  of  money,  if 
prices  did  not  increase,  would  mean  a  demand  for 
goods  far  exceeding  the  supply.  The  amount  of 
land  is  practically  constant.  Doubling  the  amount 
of  money  would  not  enable  people  to  work  longer 
hours  and  so  increase  the  products  of  labor.  In  a 
busy  community  the  supply  of  goods  to  be  sold 
simply  could  not  be  doubled  except  with  an  in- 
crease of  population  or  invention.  The  increased 
money  would  therefore  mean  that  at  the  old 
prices  the  demand  for  goods  in  general  would 
exceed  the  supply.  Purchasers  would  bid  against 
each  other.  Prices  would  rise.  Equilibrium 
would    only    be    reached,    supply    and    demand    be 


The  Determination  of  Value.  35 

equal,  at  a  general  level  of  prices  nearly    (or,  if 
fiat  money,  quite)  twice  that  which  had  preceded. =^ 

21  The  quantity  tlieory  of  money  has  recently  been  attacked  by 
Professor  B.  M-  Anderson,  Jr.,  in  his  book  on  The  Value  of  Money 
(New  York — Macmillan — ,1917.  V\'e  may  profitably  digress,  per- 
haps, long  enough  to  consider  the  bearing  of  three  of  his  hypothet- 
ical illustrative  cases.  In  the  first  (pp-  150,  151),  Professor  Ander- 
son supposes  a  paper  money  convertible  not  in  gold  but  in  varying 
quantities  of  silver  such  that  the  amount  of  silver  receivable  for  a 
unit  of  the  paper  is  always  the  equivalent  of  a  definite  weight  in 
gold.  Under  these  circumstances,  he  asserts:  "The  causation  as  be- 
tween quantity  of  money  and  value  of  money  would  be  exactly  the 
reverse  of  that  asserted  by  the  quantity  theory.  A  high  value  of 
money  would  mean  lower  prices.  With  lower  prices,  less  money 
would  be  needed  to  carry  on  the  business  of  the  country.  Paper 
would  then  be  super-abundant-  But  in  that  case,  paper  would 
rapidly  be  sent  in  for  redemption  and  the  quantity  of  money  would 
be  reduced."  But  is  it  not  true  that  the  paper  money  will  not  be 
presented  for  redemption?  On  the  contrary,  the  conditions  assumed 
by  Professor  Anderson  are  precisely  those  which  would  prevent  the 
sending  in  of  the  paper  money  for  redemption.  If  prices  are  in- 
deed lower,  those  who  possess  this  money  have  a  more  urgent 
motive  than  before  to  expend  it  while  it  will  buy  much,  rather  than 
to  have  it  redeemed.  The  paper  money  will  not  be  presented  for 
redemption  so  long  as  it  is  worth  more  in  goods  than  is  the  silver 
in  which  it  is  redeemable.  And  if  and  when  it  is  presented  for 
redemption,  this  will  be  the  result  of  a  diminished  purchasittf^  poiver 
consequent  on  its  redundancy.  In  other  words,  we  find  here  an  in- 
fluence of  the  quantity  of  money  on  the  prices  of  goods. 

In  the  second  hypothetical  case  which  we  shall  examine  (pp.  296- 
299),  Professor  Anderson  supposes  an  island  the  people  of  which  are 
chiefly  engaged  in  producing  a  single  crop  and  to  which  comes  by 
wire  the  news  of  a  partial  failure  of  the  same  crop  in  another  part 
of  the  world.  The  island  crop,  Professor  Anderson  says,  will  rise 
in  price  and  so  will  other  goods  in  the  island,  which  the  prospec- 
tivelj'  prosperous  planters  now  begin  to  buy.  All  this  may  be 
true  but  it  furnishes  no  convincing  refutation  of  the  quantity  theory 
of  money,  a  theory  which  definitely  asserts  that  both  the  quantity  of 
money  and  the  price  level  in  a  limited  territory  are  largely  deter- 
mined by  prices  outside  of  that  territory.     If,  on  the  i.dand,   prices 


36  Earned  and  Unearned  Incomes. 

In  a  country  which  has  a  gold  standard  monetary 
system  prices  are  largely  dependent  upon  the 
amount  of  gold  mined  and  hence  upon  the  number 
and   richness  of  gold   mines. 

If  prices  rose  equally,  this  would  mean  a 
doubling  in  the  money  wages  of  labor  for  the  same 
results  produced  and,  similarly,  a  doubling  in  the 

rise  before  money  floivs  in,  this  can  be  true  only  to  the  extent  that 
the  now  potentially  more  valuable  crop  is  held  for  higher  prices 
and  hence  trade  is  decreased,  or  by  virtue  of  increased  rapidity  of 
money  circulation  or,  most  importantly  perhaps,  by  the  ability  of  the 
banks,  in  anticipation  of  crop  sales  at  a  higher  price,  to  expand 
circulating  credit  (//  reserves  ivill  permit)  somewhat  farther  than 
usual.  The  quantity  theory  of  money,  properly  interpreted,  does 
not  assume  money  to  act  on  prices  in  any  other  way  than  through 
the  market  and  through  human  motives  and  calculations. 

In  the  third  case  (pp.  309,  310),  Professor  Anderson  argues  that 
reduction  of  some  prices,  if  quantity  of  money  and  volume  of  trade 
remain  the  same,  may  not  raise  other  prices  but  may  leave  a  lower 
average  of  prices  than  before.  He  supposes  that  maid-servants  who 
were  receiving  $20  a  month  have  their  wages  lowered  to  $10  by 
a  combination  of  employers  and,  having  no  better  alternatives,  con- 
tinue to  act  as  servants.  He  then  proceeds  to  contend  that  although 
the  employers  have  $10  more  each  to  spend  per  month,  the  servants 
have  each  $10  less,  that  these  changes  just  offset  each  other  and 
that,  therefore,  prices  will  not  change  except  for  the  fall  of  wages, 
the  net  effect  being  an  average  reduction.  The  $10,  according  to 
Professor  Anderson,  is  simply  "short-circuited."  The  fallacy  lies 
in  the  assumption  that  this  $io  is  expended  only  once,  e.  g.  by 
employer  to  retail  shoe  dealer,  in  the  same  period  of  time  during 
which  it  would  formerly  have  been  expended  twice,  e.  g.  by  em- 
ployer to  servant  and  by  servant  to  shoe  dealer.  Why  not  assume 
that,  if  the  servant  fails  to  connect  with  the  $10,  it  goes  from  the 
employer  to  the  retail  shoe  dealer  and  from  the  shoe  dealer  to  the 
clothier?  On  the  latter  assumption,  the  fall  of  servants'  wages, 
with  volume  of  money  and  credit  and  volume  of  trade  unchanged, 
certainly  v^ould  mean  a  rise  in  some  other  price  or  prices.  Pro- 
fessor Anderson  has  arbitrarily  interpolated  a  decreased  velocity  of 
circulation  of   money- 


The  Determination  of  Value  37 

money  interest  received  for  "waiting."  Aside 
from  disturbing  effects  during  the  period  of 
transition,  the  rate  of  interest  would  be  the  same 
with  the  high  prices  as  with  the  low.  The  money 
value  of  the  sum  waited  for  would  be  doubled  and 
the  money  value  of  the  interest  would  be  doubled. 
The  ratio  between  them  would  be  the  same  as 
before.  In  other  words,  since  prices  have  doubled, 
borrowers,  for  example,  would  require  twice  as 
many  dollars  as  before  and  would  also,  of  course, 
pay  twice   as  many   dollars   in   interest. 

In  the  light  of  the  principles  above  set  forth, 
regarding  supply  and  demand,  we  can  explain  why 
the  excessive  amounts  of  inconvertible  paper 
money  sometimes  issued  by  governments,  issued 
particularly  in  time  of  war,  have  resulted  in  very 
exceptional  rises  in  the  price  level.  This  in- 
creased amount  of  money  means,  at  any  level  of 
prices,  a  greater  demand  for  goods.  Therefore, 
that  the  demand  for  goods  may  not  exceed  the 
supply,  the  level  of  prices  must  rise.  There  is 
another  factor  of  importance  at  such  times,  viz., 
public  confidence  in  the  money  issued.  If  there 
is  a  general  belief  that  the  money  will  become 
absolutely  valueless  or  greatly  decrease  in  value, 
then  many  who  have  goods  to  sell  will  refuse  to 
sell  them  for  this  money,  but  will  demand  gold  or 
silver  or  other  goods  in  exchange.  This  decrease 
in  the  supply  of  goods,  offered  for  money,  will 
mean  that  only  a  higher  level  of  prices  than  other- 
wise would  result  can  equalize  supply  and  demand. 
Thus  is  to  be  explained  the  high  prices  (and, 
reciprocally,  the  great  depreciation  of  money)  in 
such  periods  as  the  American  Revolution,  the 
Civil  War,  etc. 


38  Earned  and  Unearned  Incomes. 

§   8 

The    Relation    of    Commercial    Banking    to    the 
General  Level  of  Prices 

Credit  instruments,  or  credit  rights — for  the 
paper  is  in  each  case  but  evidence  of  the  underlying 
obligation — act  as  substitutes  for  money  primarily 
through  the  intermediation  of  commercial  bank- 
ing,-- and  foreign  exchange  banking.  Commercial 
banks  constitute  an  important  part  of  the  mechan- 
ism of  trade.  Their  work  facilitates  internal  trade 
and,  in  connection  with  the  work  of  foreign 
exchange  banks  and  brokers,  facilitates  external 
trade  as  well.  It  is  estimated  that  nine-tenths  of 
the  total  business  in  the  United  States  is  carried 
on  through  the  use  of  bank  credit.-^ 

Bank  deposits  (rights  to  draw  from  a  bank  or 
banks),  which  circulate  by  means  of  checks,  may 
come  into  being  in  any  one  of  several  ways.  One 
may  become  a  depositor  by  directly  depositing 
money  (or  the  right  to  draw  money,  received  by 
check  from  some  one  else,  but  this  merely  registers 
a  transfer  of  a  deposit  and  does  not  create  one) . 
One  may  become  a  depositor  by  borrowing  from  the 
bank  in  which  the  deposit  is  to  be.  If  A  goes  to 
his  bank  and  leaves  there  $50,000  cash,  he  there- 
upon is  said  to  have  deposited  such  an  amount  in 
the  bank  and  can  draw  on  this  sum  at  will   by 

22  Savings  banks  and  investment  banks  perform,  of  course,  im- 
portant functions,  but  do  not  have  a  part  in  providing  a  substitute 
for  money. 

23  See  Fisher,  The  Purchasing  Foiver  of  Money,  New  York  (Mac- 
millan),  1911,  pp-  317,  318. 


The  Determination  of  Value  39 

issuing  checks  against  it  in  favor  of  any  persons 
to  whom  he  wishes  to  make  payments.  But  A  may 
also  go  to  the  same  bank,  give  his  endorsed  note 
or  other  satisfactory  security,  and  borrow  $50,000. 
This  money  he  leaves  on  deposit.  The  bank  is 
then  said  to  lend  its  credit.  What  A  has  borrowed 
is  not  money  but  the  right  to  draw  money  by 
check,  at  will.  The  bank  is  under  as  much  obliga- 
tion to  redeem  his  checks  on  demand  as  if  he  had 
directly  put  money  into  the  bank.  On  the  other 
hand,  A  is  under  obligation  to  pay  the  bank,  when 
his  note  matures,  the  amount  borrowed  plus 
interest.  Finally,  one  may  also  become  a  depositor 
by  endorsing  to  his  bank  a  note  or  draft  payable 
by  a  third  party  who  then  is  the  real  borrower. 

It  should  be  readily  apparent  that  a  bank  can,  in 
ordinary  times,  redeem  all  checks  presented  for 
redemption,  without  keeping  for  that  purpose  a 
cash  reserve  which  at  all  nearly  equals  its  liabilities. 
The  total  value  of  deposits  which  a  bank  is  under 
obligation  to  pay  out  on  demand,  may  be  $500,000. 
Yet  it  is  certain  that  all  the  depositors  will  not 
call  for  their  money  at  the  same  time.  Instead  of 
drawing  it  out,  most  of  them  send  checks  back 
and  forth  to  and  from  others  who  do  likewise.  A 
cash  reserve  of  $100,000  may  be  ample.  Putting 
the  matter  in  the  opposite  way,  we  may  assert  that 
if  there  is  $100,000  in  cash  in  such  a  bank,  the 
bank  can  lend  its  credit,  i.  e.  more  deposits  or 
rights  to  draw,  to  the  extent  of    (say)    $400,000. 

We  have  said  that  different  depositors  in  a  bank 
liquidate  their  obligations  to  each  other  by  giving 
checks.  There  is,  then,  simply  a  change  on  the 
bank's  books.     Any  amount  of  obligations  can  be 


40  Earned  and  Unearned  Incomes. 

thus  balanced.  Different  persons  are  made  success- 
ively creditors  of  the  bank  for  larger  or  smaller 
sums.  The  situation  is  complicated,  but  the 
principle  is  not  changed,  when  depositors  of 
different  banks  have  business  dealings  with  each 
other.  In  this  case,  which  is  a  decidedly  usual  one, 
the  banks  become  successively  each  other's  debtors 
and  creditors  and  have  to  settle  through  a  clearing 
house.  Bank  A  may  have  accepted  and  paid  cash 
for,  or  credited  to  depositors,  many  checks  on 
Bank  B.  Bank  B  therefore  owes  Bank  A.  Similar- 
ly, Bank  C  may  owe  Bank  B,  etc.  All  of  these 
complicated  obligations  are  balanced  by  a  clear- 
ing house,  so  that  each  bank  pays  what  it  owes  net 
or  receives  what  is  owed  to  it  net,  and  a  great 
deal  of  flow  of  money  is  avoided.  In  other  words, 
the  principle  of  cancellation  is  applied  whenever 
possible  between  banks,  just  as  it  is  in  any  one 
bank  to  the  depositors  in  it. 

The  general  level  of  prices  is  somewhat  higher 
and  the  value  of  money  is  somewhat  lower,  because 
of  the  additional  use  of  credit.  The  conditions  of 
supply  and  demand  require  a  somewhat  higher 
level  of  prices,  just  as  we  have  seen  that  they  do 
when  there  is  more  money.  Gold  is  cheaper.  The 
demand  for  it  is  less.  It  does  not  need  to  be 
produced,  and  cannot  profitably  be  produced,  at 
such  a  low  margin,  i.  e.  from  such  unfavorable 
sources  of  supply,  as  would  otherwise  be  worth 
while.  But  this  bank  credit  is  not  altogether  an 
addition  to  currency;  it  decreases  the  amount  of 
gold  money,  and  so  is  largely  a  substitution  of  a 
cheaper  for  a  dearer  currency. 


The  Determination  of  Value  41 

But  if  bank  credit  can  thus  take  the  place  of 
money,  is  there  any  limit  to  such  substitution? 
Why  might  not  credit  expand  and  prices  rise,  or 
money  be  pushed  out,  indefinitely?  The  answer  is 
that  the  amount  of  bank  credit  is  pretty  definitely 
related  to  the  amount  of  money.  In  the  first  place, 
a  certain  amount  of  cash  is  needed  in  the  banks, 
to  maintain  confidence.  The  amount  so  needed 
bears  a  relation  to  the  amount  of  bank  credit,  and 
must  be  some  reasonable  per  cent  of  such  credit. 
Otherwise,  the  public  is  likely  to  become  frightened 
and  demand  cash,  and  this  cash  cannot  be  paid. 
A  margin  against  such  contingencies  is  always 
essential  and,  for  national  banks  of  the  United 
States  and  Federal  reserve  banks,  as  well  as 
frequently  for  State  banks,  is  required  by  law. 
So  the  total  bank  credit  is  related  to  the  total  bank 
reserves  or  cash  in  the  banks.-*  Banks  main- 
tain the  proper  relation  between  deposits  and 
reserves,  by  adjusting  their  rates  of  interest  (or 
discount)  charged  to  borrowers.  If  the  deposits 
are  in  danger  of  becoming  too  great,  relative  to 
the  reserves,  a  higher  charge  to  borrowers  will 
discourage  borrowing,  and  so  will  limit  the  in- 
crease of  those  deposits  which  originate  in  the 
borrowing  of  deposit  rights  (or  in  the  discounting 
of  notes  and  acceptances). 

The  total  bank  credit  is  related,  also,  to  the  total 
cash  in  circulation.'-''  Bank  deposits  passed  by 
means    of   checks    are    absolutely    unavailable    for 

2*  White,  Money  and  Banking,  third  edition,  Boston  (Gir.n),  1908, 
p-  197.  The  reserves  required  of  national  banks  now  have  to  be 
kept  as  deposits  in  the  Federal  reserve  banks- 

-•'  Fisher,  The  Purcliasing  Po'iver  of  Money,  p.  50. 


42  Earned  and  Unearned  Incomes. 

very  many  transactions.  They  are  unavailable 
when  the  maker  of  a  check  is  unknown,  and  they 
are  unavailable,  practically,  for  small  payments, 
such  as  street  car  fares.  Even  bank  notes  cannot 
fill  up  the  entire  circulation  when,  as  is  usually 
the  case,  the  government  allows  them  to  be  issued 
only  in  relatively  large  denominations.  The 
smaller  denominations  are  needed  and  government 
money  is  used.  Business  convenience,  then,  also 
compels  a  relationship  between  the  quantity  of 
bank  credit  and  the  quantity  of  government  money. 
Since  the  quantity  of  bank  credit  is  related  in 
these  two  ways  to  the  quantity  of  government 
coined  and  government  issued  money,  changes  in 
the  latter  tend  to  bring  proportionate  changes  in 
the  former.  It  is  still  true  that  prices  depend  upon 
the  quantity  of  money,  though  the  dependence  is  in 
part  indirect.  The  demand  for  goods  comes  from 
those  who  have  bank  credit  to  offer  as  well  as 
from  those  who  have  only  money. 

§   9 

Summary 

We  began  our  study  of  value  by  assuming  the 
simplest  possible  situation  in  which  the  principal 
value-determining  forces  might  work,  viz.  a  place 
inhabited  by  a  single  isolated  man.  Though  in 
such  a  situation  no  exchanges  are  possible  and, 
therefore,  no  value,  in  the  sense  of  power  in 
exchange,  is  possible,  there  may  nevertheless  be 
comparisons  of  utility.  Such  an  isolated  man  may 
choose  to  produce  one  thing  instead  of  another 
because    its    utility    is    greater    to    him    than    the 


The  Determination  of  Value  43 

utility  of  the  other,  in  relation  to  the  time  and 
intensity  of  labor  necessary  to  produce  it.  It  is 
likewise  true  for  a  person  so  situated,  as  for  a 
person  in  a  modern  community,  that  a  given  unit  of 
any  good  has  less  utility  according  as  he  possesses 
many  units.  If  one  kind  of  good  has,  because  he 
possesses  little  of  it,  greater  utility  to  him  than 
another,  and  is  yet  no  harder  to  produce,  he  will 
devote  his  attention  to  producing  it  instead  of  the 
other  until  the  relative  utilities  are  as  the  relative 
sacrifices  or  costs  of  its  production.  But  this  ad- 
justment may  be  reached  either  because  the  utility 
of  the  desired  good  becomes  less  as  more  of  it  is 
possessed,  or  because  the  labor  of  producing  it 
becomes  greater  in  proportion  when  more  is 
wanted,  or  for  both  reasons.  Some  wants  will 
eventually  remain  unsatisfied  because  they  are  not 
important  enough  to  warrant  the  sacrifices  of 
production,  sacrifices  which  are  likely  to  grow 
greater  in  proportion  to  the  results  obtained,  as 
more  hours  per  day  are  devoted  to  labor. 

In  a  modern  community,  the  relatively  large 
production  of  the  most  desired  goods  is  brought 
about  through  the  influence  of  desire  upon  demand 
and  of  demand  upon  the  profitableness  of  supplying 
these  goods.  The  principle  of  diminishing  utility 
still  applies  and  each  purchaser  buys  goods  desired 
by  him  only  up  to  the  point  where  the  last  unit 
purchased  has  a  utility  equal  to  the  utility  of  the 
money  which  must  be  paid  for  it,  which  will  be 
equal  to  the  utility  of  the  most  desired  alternative 
purchase  that  might  have  been  made  with  the 
money.  The  goods  which  are  generally  so  desired 
in  quantity  that  the  average  purchaser  buys  much 


Mo^ 


44         Earned  and  Unearned  Incomes. 

before  their  utility  becomes  as  low  as  the  price, 
are  goods  which,  therefore,  it  pays  to  produce  in 
large  amounts.  Many  persons  and  much  land  and 
capital  are  devoted  to  producing  these  goods. 
In  a  general  way,  we  can  state  that  producers  carry 
on  productive  effort  up  to  the  point  where  its 
discomfort,  weariness  or  disutility  balances  the 
satisfaction  or  utility  which  is  the  reward  of  that 
effort.  But  we  cannot  say  that  the  disutility  of 
productive  effort,  to  the  producer,  equals  the 
utility  of  the  goods  produced,  to  the  consumer. 

A  modern  community  is  made  up  of  specializing 
units ;  specialization  requires  exchange ;  and  ex- 
change involves  a  rate  or  rates  of  exchange.  In 
other  words,  exchange  involves  demand  and  supply. 
It  is  the  forces  of  the  market  which  fix  the  price 
of  any  good  at  the  point  where  demand  and 
supply  are  equal.  At  a  lower  price,  demand 
would  exceed  supply  and  buyers  would  bid  against 
each  other,  so  raising  the  price.  At  a  higher 
price,  supply  would  exceed  demand  and  sellers 
would  bid  against  each  other  in  order  to  dispose 
of  the  goods.  Demand,  supply  and  price  have 
reference  to  a  period  of  time  which  may  be  shorter 
or  longer  according  as  we  are  concerned  with 
market,  seasonal  or  normal  price. 

Speculative  buying  and  holding  for  a  rise  tends 
to  keep  up  the  prices  of  agricultural  products  when 
they  first  come  upon  the  market  and  to  prevent 
scarcity  and  high  prices  later.  The  selling  of 
"futures"  also  tends  towards  equalization  of  prices. 
But  speculation  by  persons  inexpert  in  it  may  tend 
to  increase  price  fluctuations  instead  of  to  diminish 
them. 


The  Determination  of  Value  45 

The  general  average  of  prices  or  price  level  is 
also  determined  by  demand  and  supply  and  largely 
resolves  itself  into  a  relation  between  the  volume 
of  purchasing  power  in  the  form  of  money  and 
bank  deposit  (checking)  accounts  on  the  one  hand 
and  the  volume  of  trade  on  the  other  hand. 


CHAPTER    II 

Ultimate  Determinants  of  Value 


Supply    of   One    Good   Mea^is    Demand    for   Other 

Goods 

If  our  explanation  of  the  determination  of  value 
is  to  approximate  completeness,  we  must  not  stop 
with  an  analysis  of  the  nature  of  demand  and 
supply,  but  must  bring  into  view  the  forces  which 
lie  back  of  each.  We  shall  begin  with  demand.  It 
was  said  in  the  last  chapter  that  desire  is  not 
demand.  Nevertheless,  desire  is  related  to  demand 
as  (part)  cause  to  effect.  Demand  depends  upon 
desire  for  goods  coupled  with  ability  to  pay  for 
them.  Other  things  equal,  the  greater  the  desire  for 
any  goods,  the  greater  the  demand  for  them.  The 
desire  of  an  isolated  man  for  goods  of  any  kind, 
expresses  itself  in  his  efforts  to  produce  these 
goods.  But  where,  as  in  a  modern  community, 
there  is  division  of  labor,  each  member  of  the 
community  specializing  in  some  one  line,  demand 
for  any  good  on  the  part  of  producers  of  other 
things,  expresses  itself  in  their  production  of 
these  other  things  for  a  market,  in  order  that  they 
may  have  the  means  to  purchase  what  they  desire. 
In  effect,  though  the  use  of  money  intervenes,  they 
buy  the  goods  they  desire  with  the  goods  they 
produce.  If  the  farmer  desires  a  piano,  an 
automobile,  good  furniture  and  various  other 
things,  he  works  longer  hours  or  more  Intensively 
and   produces   more   wheat,   cotton,   corn   or   beef. 

(46) 


I 


Ultimate  Determinants  of  Value         47 

Thus  the  goods  of  one  kind,  which  he  supplies, 
express  and  give  effect  to  his  demand  for  other 
goods. 

It  is  this  fact  which  lay  back  of  the  contention  of 
the  classical  economists,  that  there  could  be  no 
such  thing  as  a  cjeneral  oversupply,  i.  e.  the  supply 
of  a  larger  amount  of  all  kinds  of  goods  than 
could  be  sold.  There  might  be,  through  mis- 
calculation of  producers,  or  other  cause,  an  over- 
supply  of  one  or  a  few  kinds  of  goods  compared 
to  other  goods.  But  this  simply  meant  that  the 
producers  of  the  goods  supplied  in  excess,  say 
cotton,  had  plenty  of  those  goods  with  which  to 
purchase  other  goods.  They  had  produced  what, 
they  believed,  would  be  satisfactory  means  of 
payment  for  the  goods  desired.  That  is,  they 
had  intended  to  produce  marketable  goods.  They 
had  mistakenly  produced  too  much  of  one  thing 
(or  a  few  things).  But  to  assume  that  nothing 
they  could  have  produced  would  have  been  accept- 
able to  those  with  whom  they  traded,  would  be  to 
assume  that  the  latter  had  no  wants  remaining  un- 
satisfied, for  the  satisfaction  of  which  they  were 
willing  to  pay.  But  if,  in  our  system  of  division 
of  labor,  these  latter,  the  purchasers  of  cotton, 
have  produced  any  goods,  it  must  be  because  they 
desire  and,  therefore,  have  a  demand  for,  other 
goods,  such  as  cotton.  Though  they  do  not  desire 
(and,  except  at  low  prices,  will  not  take)  all  of 
the  cotton  which  has  been  too  freely  produced, 
they  do  desire  other  goods  and  have  produced  the 
wherewithal  to  pay  for  them.  In  other  words, 
people  produce  goods  in  modern  ^^ociety  chiefly  as 
a  means   of   getting   other   goods.     Production    of 


48  Earned  and  Unearned  Incomes. 

goods  by  a  person  who  intends  to  sell  them  es- 
tablishes a  strong  presumption  that  he  wants 
something  else,  that  his  wants  are  not  satisfied. 
What  he  wants  to  buy  may  be  factories,  railroad 
shares,  office  buildings  and  tenements,  but  it  is 
pretty  certain  that  he  wants  to  buy  something.  If 
he  puts  his  money  into  a  savings  bank,  the  situation 
remains  the  same,  for  he  merely  makes  the  bank 
his  agent.  The  bank  invests,  i.  e.  buys,  for  account 
of  its  depositors.  General  overproduction  would 
mean,  then,  a  more  or  less  universal  production  of 
goods  for  sale,  by  persons  who  did  not  want  other 
goods  in  exchange  for  the  goods  sold.  It  would 
mean  a  desire  to  sell  goods  but  no  corresponding 
desire  to  buy  goods.  Since,  in  general,  men  sell 
only  that  they  may  buy,  such  a  situation  as  a 
general  phenomenon  is  almost  unthinkable.  It 
may  seem  to  exist  temporarily,  and  for  special 
reasons,  during  a  panic  and  business  disorganiza- 
tion, but  it  is  very  far  from  being  a  normal  condi- 
tion of  economic  life ;  nor  can  general  oversupply, 
though  seeming  to  exist  during  such  a  business 
breakdown  because  merchants  and  manufacturers 
are  afraid  to  buy  the  usual  amounts  of  goods,  raw 
material  and  machinery,  be  put  forth  as  a  cause 
of  the  breakdown.  In  fact,  the  refusal  of  dealers 
and  manufacturers  to  buy  does  cause  it  to  appear 
that  there  is  a  surplus  of  goods,  discourages 
manufacturers  of  those  goods,  throws  men  out  of 
work,  deprives  these  men  of  the  means  of 
purchasing,  and  so  accentuates  the  appearance  of 
superfluity.  But  the  condition  is  one  of  industrial 
breakdown   rather  than   of  too   efficient  industrial 


Ultimate  Determinants  of  Value         49 
functioning.'      Provided    our    economic    machinery 

1  Professor  Davenport  says  (Economics  of  Enterprise,  New  York — 
Macmillan — ,  1913,  p.  362)  that  in  a  time  of  depression  "goods 
are  offering  against  present  money,  while  money  is  offering  only 
against  promises  to  pay  in  later  goods  or  in  later  money  with  which 
presumably  to  command  later  goods-  .  .  .  The  offers  of  present 
goods  are  not  for  present  goods,  and  the  offers  of  present  money  are 
not  offers  for  present  goods."  In  other  words,  everybody  seems  anx- 
ious to  sell  for  money  and  relatively  few  seem  anxious  to  spend 
money. 

To  this  one  might  reply  that,  although  it  seems  to  picture  fairly 
well  the  situation  during  depression,  yet  the  difficulty  is  that  sellers 
of  goods,  despite  apparent  eagerness  to  sell,  are  nevertheless  asking 
prices  higher  in  money  than  buyers  are  willing  to  give,  and  that 
a  revaluation  of  their  goods  by  sellers,  on  a  lower  basis,  would  en- 
able them  to  be  sold-  Professor  Davenport  contends,  to  be  sure 
(ibid,  p.  303),  that  falling  prices  may  not  terminate  the  glut,  since  if 
the  purchasing  power  of  money  over  present  goods  is  thus  rising, 
"so  also  is  rising  its  putative  future  purchasing  power."  But  this 
can  hardly  be  true  without  limit.  At  some  degree  of  lowness  of 
prices,  purchasers  of  goods  must  realize  that  a  better  time  to  buy 
can  hardly  be  expected  to  arrive.  There  must  be  a  scale  of  prices 
at  which,  could  it  be  generally  accepted,  goods  would  exchange 
freely,  not  reluctantly,  for  other  goods  through  the  medium  of  money- 
Indeed,  Professor  Davenport  goes  on  to  mention  such  considera- 
tions by  way  of  accounting  for  the  eventual  revival  from  depres- 
sion- 

But  be  this  as  it  may,  assuming,  for  example,  that  all  persons 
who  have  money  are  unwilling  to  spend  it  at  any  set  of  prices 
of  goods,  while  all  holders  of  goods  are  anxious  to  dispose  of  them 
for  money  on  any  terms,  does  it  not  still  follow  that  all  who  have 
or  produce  goods  for  sale  are  demanders  of  other  goods?  In  the 
assumed  case,  they  are  deniantlers  of  money;  and  this  means,  in 
effect,  in  a  gold  standard  country,  that  they  are  demanders  of  gold. 
Temporarily,  at  least,  the  value  of  gold — or  other  primary-money 
commodity — is  raised.  Could  such  a  condition  continue,  it  would 
stimulate  the  production  of  gold  and  lead  to  the  employment  of 
more  men  to  find  and  to  work  gold  deposits-  So  far  from  there  be- 
ing an  all-round  oversupply  of  goods,  we  could  say  with  truth  that 


50  Earned  and  Unearned  Incomes. 

works  smoothly,  we  need  not  fear  a  superfluity  of 
goods,  and  when  we  appear  to  have  such  super- 
fluity, the  real  difficulty  is  to  be  sought  elsewhere. 

§   2 
Influences  Back  of  Demand 

Intensity  of  demand  for  goods  shows  itself,  as 
has  been  above  stated,  in  intensity  of  effort  devoted 
to  producing  other  goods  with  which  to  buy  them. 
But  intensity  of  demand  for  any  one  kind  (or  a 
few  kinds)  of  goods,  may  show  itself  also  in  a 
smaller  consumption  of  other  kinds,  and  in  using 
most  of  one's  available  purchasing  power  to  buy 
the  goods  most  wanted.  In  other  words,  our 
estimates  of  relative  utility  inevitably  involve  not 
one  but  two  comparisons  or  sets  of  comparisons.  We 
must  compare  the  utility  of  goods  desired  with  the 
cost  of  the  goods  in  terms  of  what  we  produce  to 
pay  for  them  and,  therefore,  in  terms  of  the  dis- 
utility (of  effort  and  other  sacrifice)  involved  in 
producing  the  latter  goods.  We  must  also  compare 
the  utility  of  any  special  goods  desired,  with  the 

there  was  a  relative  undersupply  of  gold.  Perhaps  it  is  better,  in 
view  of  the  above  complex  of  considerations,  not  to  assert  absolutely 
that  all-round  overproduction  is  impossible.  During  depression  there 
is  a  condition  which  often  seems  like  all-round  oversupply,  or  prac- 
tically that.  And  it  is  of  too  temporary  a  nature,  perhaps,  to  war- 
rant a  shift  of  surplus  labor  to  gold  production  even  if  that  were 
in  less  degree  than  is  the  case  on  aleatory  industry.  Of  course,  also, 
where  the  currency  is  of  the  fiat  order  a  temporary  apparent  re- 
lative undersupply  of  it,  of  the  kind  here  in  question,  could  not 
give  opportunity  for  much  employment  of  idle  labor  in  producing  it. 
But  that  the  difficulty,  in  its  origin,  is  always  one  of  maladjustment 
rather  than  of  too  much  production  everywhere,  should  be  clear. 


I 


Ultimate  Determinants  of  Value         51 

utility  of  other  goods  which  might  be  purchased 
instead  but  which,  because  our  earning  power  is 
not  unlimited,  may  have  to  be  sacrificed  if  the 
special  goods  most  wanted  are  bought. 

To  illustrate,  a  farmer's  desire  for  a  piano  may 
cause  him  to  work  longer  hours  and  cultivate  his 
farm  more  intensively,  in  order  to  produce  the 
extra  amount  of  wheat  necessary  for  purchasing 
the  piano  without  greatly  sacrificing  his  other 
needs.  His  sacrifice  takes  then  the  form  of  the 
extra  effort  required  to  earn  the  requisite  money. 
On  the  other  hand,  his  desire  for  the  piano  may, 
conceivably,  cause  him  to  work  no  harder  but  may 
induce  him  to  give  up  owning  an  automobile.  In 
that  case,  his  sacrifice  takes  a  different  form, 
but  may  be  regarded  as  none  the  less  a  sacrifice. 
The  same  principle  applies  to  anything  which  one 
may  purchase, — coal,  shoes,  sugar,  etc. 

We  have  already  seen-  that  as  a  person  has  more 
and  more  units  of  any  article,  the  utility  or 
desirability  of  additional  units  declines.  A  pound 
of  sugar,  to  a  man  who  could  never  have  but  a 
single  pound,  would  be  highly  prized.  A  second 
pound  would  be  somewhat  less  desired  but  would 
yet  have  high  utility.  But  to  a  man  who  regularly 
consumes  75  pounds  of  sugar  a  year,  one  pound 
more  or  less  is  of  relative  unimportance.  In  the 
case  of  some  goods,  utility  would  diminish  rapidly 
as  the  amount  owned  increased.  In  the  case  of 
other  goods,  utility  would  diminish  slowly.  In  any 
case,  a  person  desiring  the  goods  would  purchase 
them  up  to  the  point  where  the  last  unit  secured 

2  Chapter  I,  §i. 


52  Earned  and  Unearned  Incomes. 

was  just  equal,  in  his  mind,  to  the  price  paid.  The 
purchaser  of  sugar  would  buy  each  year  or  each 
month  such  an  amount  that  the  last  pound  pur- 
chased would  just  about  seem  worth  while  getting 
at  the  price.  The  purchaser  of  coal  would  buy, 
each  winter,  such  a  number  of  tons  that  the  last 
ton  would  just  about  seem  worth  the  price  paid. 
If  the  price  were  lower  he  might  luxuriate  in 
more  heat.  If  it  were  much  higher,  he  might 
endeavor  to  get  along  with  one  less  heated  room. 
The  last  ton  purchased  would  just  about  seem 
to  be  the  equivalent,  in  utility,  of  the  money  spent 
for  it  or  (since  money  has  utility  only  for  what  it 
can  buy)  of  the  other  goods  which  could  have 
been  secured  with  the  price  of  that  ton  but  which 
are  sacrificed  in  order  to  get  the  coal.  This  last 
ton,  being  just  equal  in  utility  to  the  money  neces- 
sary for  its  purchase,  would  just  compensate  for 
the  disutility  (labor  or  other  sacrifice)  involved 
in  earning  that  last  addition  to  the  year's  income. 
This  statement  remains  true  in  principle  even 
when  the  assumed  purchaser  of  goods  finds  labor 
a  constant  delight.  For  such  labor  still  involves 
a  sacrifice  of  sleep,  or  leisure  or  reflection,  which 
may  be  no  less  or  even  more  delightful  to  him. 
As  to  the  person  who  gets  all  or  nearly  all  his 
income  from  property,  it  can  hardly  be  said  that 
the  last  hour's  work  has  any  disutility  at  all. 
But,  even  so,  goods  may  still  be  valued  in  terms 
of  other  goods  foregone.^  The  last  ton  of  coal 
purchased  is  called  the  marginal  purchase,  its 
utility,  marginal  utility,  the  effort  or  other  sacri- 

3  See   Davenport,   Economirs   of  Enterprise,  p.   93. 


Ultimate  Determinants  of  Value         53 

fice  necessary  to  earn  that  much  more  (e.  g.  the 
last  and,  therefore,  hardest  or  most  disagreeable 
hour's  work,  if  work  must  be  undergone)  is  the 
marginal  effort  or  sacrifice,  and  its  disutility  is  the 
marginal  disutility.  At  the  point  where  the  coal 
purchasing  stops,  the  marginal  utility  of  coal  is 
just  equal  to  the  marginal  utility  of  money  or  of 
the  goods  other  than  coal  for  which  the  money 
might  be  spent  and,  if  the  money  had  to  be  earnad, 
is  just  about  equaP  to  the  marginal  disutility  ol 
earning  that  money. 

We  may  now  restate  the  relation  of  demand  to 
price,  pointing  out  that  demand  rises  as  price 
falls  and  that  this  is  true  partly  because  a 
fall  of  price  induces  some  to  be  purchasers  who 
would  not  buy  at  a  high  price,  and  partly  because 
those  who  would  buy  at  a  high  price  will  buy  more 
if  price  be  lower. 

A  further  statement  may  be  made,  which  has  to 
do  with  both  demand  and  supply.  A  great  rise 
in  the  price  of  (say)  wheat,  would  tend  to  de- 
crease the  demand  for  wheat  by  persons  producing 
other  goods  to  get  it,  partly  because  it  would  induce 
some  to  give  up  producing  the  means  of  purchasing 
wheat  and  to  produce,  instead,  the  wheat  itself. 
On  the  other  hand,  a  great  decrease  in  the  price 
of  wheat  (resulting,  perhaps,  from  the  invention  of 
better  harvesting  machinery  and  from  improved 
methods  of   soil   enrichment"),   would   tend   to   in- 

*  Not  necessarily  exactly  equal  sinre  the  money  may  be  earned  at 
one  time  and  spent  at  a  later  time,  and  since,  therefore,  its  utility 
may  be  different  from  its  estimated   utility- 

5  These  improvements,  other  things  equal,  mean  that  fewer  are 
required    to    produce    wheat,    and,    therefore,    unless    some    change 


54  Earned  and  Unearned  Incomes. 

crease  the  demand  for  it  by  causing  some  who  had 
been  producers  of  wheat,  to  produce  other  things 
and  therewith  buy  wheat.  Otherwise  putting  the 
matter,  we  may  say  that  the  amount  v/hich  would 
be  paid  for  wheat  in  terms  of  other  goods,  is 
roughly  limited  (if  we  have  long  periods  and 
possible  change  of  occupation,  in  view)  to  the 
amount  of  other  goods  which  could  be  produced 
with  the  same  (marginal)  sacrifice  as  the  wheat. 
A  price  of  wheat  so  high  that  it  is  much  more 
difficult  to  get  the  wheat  desired,  by  producing 
other  goods  with  which  to  buy  it,  than  to  produce 
the  wheat  itself,  would  mean  a  smaller  demand 
for  wheat,"  and  demand  and  supply  would  only 
be  equalized,  in  the  long  run,  by  a  shifting  of  a 
part    of    the    community's    producing    power    into 

their  occupation,  prices  will  fall  so  far  as  to  make  wheat  production 
relatively  unprofitable.  That  is,  prices  will  fall  more  than  the  im- 
provement  in   methods  can  permanently  justify. 

^  Unless  we  think  of  wheat  producers  as  being  demanders  of 
wheat,  directly  or  indirectly,  from  themselves.  Considered  as  a 
group,  however,  the  producers  of  wheat  and  wheat  products  are 
suppliers  of  wheat  to  the  rest  of  the  community-  The  part  of  the 
product  that  they  themselves  consume,  they  cannot  be  said  (as  a 
group)  to  demand,  in  the  sense  of  buying  it  with  other  goods. 
Hence,  if  other  producers  are  pushed  or  drawn  into  wheat  produc- 
tion, because  of  high  wheat  prices,  the  demand  for  wheat  may  be 
said  to  be  smaller.  In  a  more  detailed,  and,  therefore,  perhaps, 
less  philosophical  sense,  producers  of  wheat  may  be  said  to  demand 
wheat,  indirectly,  if  they  sell  their  wheat  and  buy  wheat  flour.  Their 
demand  for  the  flour  from  the  millers  is,  indirectly,  a  demand  for 
wheat  since  it  occasions  demand  for  wheat  by  the  millers.  In 
this  sense,  the  wheat  producers  may,  often,  literally  buy  back 
their  own  wheat.  It  is  possible,  in  short,  to  conceive  of  the  wheat 
consumed  by  the  wheat  producers  themselves  as  entering  into 
neither  demand  nor  supply,  or  to  conceive  of  it  as  entering  into 
both. 


Ultimate  Determinants  of  Value.        55 

wheat  production.  There  is  a  very  real  sense, 
then,  in  which  the  demand  for  an  article,  and  the 
amount  which  consumers  will  pay  for  it,  depends 
upon  its  cost  of  production.  They  will  not,  in  the 
long  run,  pay  more  for  it  than  the  amount  of 
other  goods  which  the  same  sacrifice  will  produce. 
Normal  or  long  run  demand  may  therefore  be 
said  to  depend  on  the  (marginal)  utility  of  the 
goods  demanded,  on  the  (marginal)  utility  of  the 
other  goods  which  M'ill  have  to  be  sacrificed  if 
these  are  enjoyed,  on  the  (marginal)  disutility  or 
sacrifice  of  producing  the  goods  necessary  to  pay 
for  the  desired  goods,  and,  by  way  of  comparison," 
on  the  disutility  or  sacrifice  necessary  to  produce, 
instead  of  buying,  the  goods  desired. 

Cost  of  production  has  often  been  spoken  of  as 
if  it  influenced  only  supply  of  goods  and  not 
demand.  But  this,  if  the  position  here  taken  can  be 
justified,  is  not  consistent  with  a  broad  philosoph- 
ical view  of  the  phenomena  in  question.  Conditions 
of  cost  influence  demand  no  less  than  supply,^  even 
though  their  influence  on  demand  is  not  obvious 
without  a  philosophical  anal^^sis  of  economic 
relations. 

This  point  has  importance  in  the  distinction 
between  goods  which  have  and  goods  which  have 
not  any  cost  of  production,  i.  e.  between  goods 
which  are  reproducible  and  goods  which  are  almost 
or  absolutely  fixed  in  quantity.    Ordinary  commodi- 

^A  similar  comparison,  amounting  to  the  same  thing,  would 
be  one  of  the  utility  of  the  desired  goods  compared  with  the 
utility  of  other  goods  producible  at  the  same  sacrifice. 

s  If  economists  dislike  this  contention,  they  must,  it  would  seem, 
abandon  the  traditional  definitions  of  demand   and  supply. 


56  Earned  and  Unearned  Incomes. 

ties  are  in  the  first  class.  Land  space  is  in  the 
second  class.  The  demand  for  ordinary  commodities 
depends  not  only  upon  their  utility,  but  in  part,  as 
we  have  seen,  upon  their  cost  of  production,  for 
the  majoritj^  of  people  will  not  long  pay  for  any 
good  more  than  this  cost,  i.  e.  more  than  the  amount 
of  other  goods  which  the  same  effort,  etc.,  would 
produce."  But  the  demand  for  land  space  depends 
(assuming  any  given  prices)  solely  on  its  utility, 
for  it  has  no  cost  of  production. ^°  At  any  set  of 
prices  for  the  different  pieces  of  land  in  a 
community,  the  demand  would  be  almost  totally 
unaffected  by  any  possibility  of  producing  the 
desired  land  instead  of  buying  it,  for,  on  the  whole, 
and  with  a  few  exceptions  of  7nade  land,  there  is 
no  such  possibility.^^  Buyers  of  land  would 
purchase  it  up  to  the  point  where  its  utility,  for 
their  purposes,  equalled  its  price.  At  a  low  set 
of  prices,  more  land  would  be  bought  than  at  higher 

°  The  above  statement  is  made  in  general  terms  and  must  be 
taken  by  the  critical  reader  with  the  qualifications  already  made  in 
this  and  the  previous  chapter  as  to  difference  of  cost  to  diiferent 
producers,  marginal  cost,  and  dependence  of  this  cost  on  amount 
produced.  But  the  statement  as  here  made  is  sufficiently  accurate 
for  the  purpose  in  hand. 

'*^  Though  improvements  on  it,  of  course,  do  have.  But  such 
improvements  are  to  be  sharply  separated  in  thought  from  the  land 
itself. 

^1  It  is  not  the  intention  to  suggest  that  the  buyer  or  renter  of 
land  space  has  no  alternative-  He  may  use  a  smaller  piece  of  land 
more  intensively  instead  of  a  larger  piece  less  intensively.  Thus, 
he  may  put  a  twenty-story  building  on  a  small  area  instead  of  put- 
ting a  ten-story  building  on  a  larger  area.  He  may  choose  a  poorer 
site  instead  of  a  better  one-  But  the  buyer  or  renter  of  capital  has 
alternatives  of  these  kinds  and  has  in  addition  the  alternative  of 
becoming  himself  a  producer  of  the  sort  of  capital  wanted. 


Ultimate  Determinants  of  Value.        57 

prices.  But  if  the  land  were  sufficiently  desired  by 
purchasers,  to  make  the  prices  high,  their  demand 
would  not  be  likely  to  be  limited  by  any  alternative 
of  shifting  their  industry  and  becoming  producers 
of  land.  To  an  extent,  land  fertility  can  be  produced 
by  human  effort  but,  practically  speaking,  land 
space  cannot  be. 

§  3 
Influences  Back  of  Supply 

Let  us  now  analyze  the  supply  side  of  the  market 
in  the  same  way.  The  supply  of  any  good,  e.  g. 
cotton,  depends,  first,  on  the  price  that  can  be  real- 
ized for  it,  per  pound,  i.  e.  ultimately  on  the  amount 
of  other  desired  goods  obtainable  in  exchange  for 
the  cotton.  A  higher  price  would  encourage  larger 
production.  Second,  the  supply  of  cotton  depends 
upon  the  intensity  of  desire  for  these  other  goods 
securable  in  exchange  by  the  producers  of  cotton. 
Supposing  the  intensity  of  desire  for  these  goods 
on  the  part  of  cotton  producers  to  be  very  great, 
they  would  produce  large  amounts  of  cotton  with 
which  to  buy  these  other  goods.  Assuming  their 
desire  for  other  goods  to  be  weak  and  easily  satis- 
fied, they  would  care  less  to  produce  large  amounts 
of  cotton  with  which  to  buy  these  other  goods.  If 
the  producers  of  cotton  and  of  the  other  goods  for 
which  it  is  given  are  alike  members  of  a  single 
homogeneous  population,  able  to  change  easily  in 
large  groups,  from  one  occupation  to  another,  the 
intense  or  weak  demand  of  cotton  producers  for 
other  goods  will  indicate  an  intense  or  weak  de- 
mand in  the  whole  community  for  goods  in  general. 


58  Earned  and  Unearned  Incomes. 

probably  including  cotton,  and  may  not  imply  any 
special  effect  on  the  value  of  cotton  in  relation  to 
other  goods.  But  if,  as  is  the  case,  cotton  is  only 
producible  in  certain  climates,  and  if  those  who 
live  and  work  in  those  climates  are  persons  whose 
wants  are  slight  and  easily  satisfied,  the  effect  on 
the  supply  of  cotton  may  be  important.  In  trade 
between  highly  civilized  countries  on  the  one  hand 
and  primitive  peoples  on  the  other,  the  lack  of  de- 
sire upon  the  part  of  the  latter  for  anything  beyond 
a  few  simple  necessaries  of  life,  tends  (assuming 
their  labor  to  be  wholly  voluntary)  to  restrict  the 
supply  of  the  goods  they  produce  and  so  to  raise 
the  prices  of  such  goods.  This  result  will  not  fol- 
low, of  course,  if  the  goods  in  question  can  be 
cheaply  produced  in  the  civilized  country. 

Third,  the  supply  of  cotton  may  depend  upon  the 
disutility  of  producing  it,  i.  e.  the  unpleasantness 
or  difficulty  of  or  disinclination  to  do  the  work  or 
make  the  accumulations  of  capital  used  in  pro- 
ducing the  cotton.  Thus,  if  exhaustion  of  the 
soil  should  increase  the  labor  per  pound  of  produc- 
ing cotton,  this  would  discourage  its  production 
and,  if  only  the  same  price  as  before  could  be  se- 
cured, less  and  perhaps  much  less  cotton  would  be 
produced  than  before.  On  the  other  hand,  should 
improvements  in  machinery  and  in  methods  of 
soil  culture  make  the  labor  cost  per  pound  of  cotton 
less  than  before,  the  production  of  cotton  would 
be  encouraged  and,  at  the  same  price,  a  larger 
amount  of  cotton  than  before  would  be  produced 
and  sold. 

Summarizing  our  conclusions  thus  far  and  re- 
stating them,  we  may  say  that  producers  of  cotton 


Ultimate  Determinants  of  Value.        59 

will  supply  it  up  to  the  point  where  the  (marginal) 
disutility  to  them  of  producing  it  is  just  balanced 
by  the  (marginal)  utility  to  them  of  the  goods 
which  they  get  in  exchange. 

But  in  presenting  the  above  considerations,  we 
have  failed  to  emphasize  an  influence  to  which  the 
greatest  importance  should  be  attributed.  This  is 
the  influence  exerted  by  comparison,  in  the  minds 
of  producers,  of  the  various  ways  of  getting  what 
they  want  as  consumers.  Thus,  the  producers  of 
cotton  are  producing  it,  in  large  part,  as  the  most 
effective  way,  for  them,  of  securing  wheat,  bacon, 
sugar,  etc.  Should  the  price  of  cotton  greatly  fall 
or  of  these  other  things  greatly  rise,  so  that  the 
produce  of  a  year's  labor  in  cotton  raising  would 
purchase  much  less  than  before  of  these  other 
things,  some  of  the  cotton  producers  (or  persons 
who  would  have  become  such),  might  instead  turn 
their  efforts  to  other  lines,  to  producing  goods 
other  than  cotton,  which  they  could  more  profit- 
ably exchange  for  the  various  goods  they  desired, 
or  to  producing,  themselves,  some  of  these  desired 
goods  instead  of  buying  them  with  cotton.  We 
may,  indeed,  regard  the  cost  of  production  of 
cotton  as  being  the  amount  of  other  goods,  of  one 
and  another  sort,  which  the  same  effort  and  self 
denial  would  produce  and  the  production  of  which 
the  cotton  raisers  forego  when  they  raise  cotton. 
Assuming  the  possibility  of  an  easy  shifting  of 
occupations,  they  will  not  care  to  produce  cotton 
if  they  have  to  dispose  of  it  for  much  less  than 
that  amount  of  other  goods  which  the  same  eft'ort 
and  sacrifice  would  produce.  To  say  that  they 
must  take  less  than  this,  is  to  say  that  some  other 


60  Earned  and  Unearned  Incomes. 

line  (or  lines)  of  production  is  (or  are)  more 
profitable  than  cotton  raising,  and  such  a  condition 
would  tend  to  decrease  the  supply  of  cotton.^^ 

On  the  supply  side  then,  as  on  the  demand  side 
of  the  market,  in  the  case  of  any  goods,  the  cost 
of  production  is  an  important  consideration,  cost 
of  production  being  understood  to  mean  the  amount 
of  other  goods  which  the  same  effort  and  sacrifice 
would  produce.  Purchasers  do  not  wish  to  pay 
more  than  this  cost  of  production  and  will,  in 
large  part,  change  their  occupations  and  cease  to 
appear  on  the  demand  side  of  the  market,  if  they 
do  have  to  pay  more.  Sellers  do  not  wish  to  take 
less  than  this  cost  of  production  and  will,  in 
large  part,  change  their  occupations,  and  cease  to 
appear  on  the  supply  side  of  the  market  if  they 
do  have  to  take  less.  It  need  not  surprise  us  that 
demand  and  supply  are  thus  both  so  closely  related 
to  cost  in  the  sense  of  the  word  here  used.  Let 
us  remember  that  those  who  demand  one  kind  or 
several  kinds  of  goods,  supply  other  goods,  and 
that  those  who  supply  one  kind  of  goods  demand 
other  kinds.  The  demander  is  a  supplier  and  vice 
versa.  Every  person  is  at  the  same  time  a  buyer 
of  some  things  and  a  seller  of  other  things.  And 
every  person,  in  a  modern  society  based  on  indus- 
trial freedom,  has  the  alternative  of  becoming  a 
buyer  of  what  he  now  sells  and  a  seller  of  what 

^2  Another  way  to  put  the  same  thought  is  to  say  that  the  supply 
of  cotton  would  decrease  if  the  producers  of  it  have  to  expend 
more  effort  and  sacrifice  in  producing  cotton  as  a  means  of  paying 
for  other  desired  goods,  than  would  be  required  to  produce  these 
goods  direct  or  to  produce  something  other  than  cotton  with  which 
to  buy  them. 


Ultimate  Determinants  of  Value.        61 

he  now  buys.  In  fact,  every  industrial  unit  has 
many  alternatives  and  all  of  them  are  determining 
conditions  of  his  action  as  an  economic  unit  in 
industrial  society. ^-^  When  buyers,  takino;  them  as 
a  whole,  refuse,  in  the  long  run,  to  pay  for  a  good 
more  than  its  cost  of  production,  and  when  sellers, 
taking  them  as  a  whole,  refuse,  in  the  long  run, 
to  accept  less,  both  groups  are  influenced,  not  only 
by  their  available  alternatives  of  varying  their 
consumption  in  amount  or  in  proportions  and 
of  varying  the  intensity  or  degree  of  their  pro- 
ductive efforts  and  other  sacrifices,  but  also,  and, 
for  many  economic  problems,  most  importantly, 
by  their  alternative  of  shifting  their  fields  of  in- 
dustrial   activity/* 

On  the  supply  side,  as  on  the  demand  side,  it  is 
worth  while  emphasing  the  distinction  between 
goods  producible  in  indefinite  amounts,  in  relation 

13  Cf-  Professor  H.  J.  Davenport's  discussion  in  his  Economics  of 
Enterprise,  Chapter  VI. 

i*  There  is  here  no  intention  to  deny,  of  course,  that  ar.  individual 
concern  can  afford  to  charge  a  lower  price  if  it  can  fully  utilize  its 
plant  than  if  it  is  unable  to  secure  business  enough  to  utilize  its 
plant  to  anything  like  full  capacity.  Such  a  concern  might,  there- 
fore, be  willing  to  sell  a  larger  amount  of  goods  for  as  low  a 
price  as  that  for  which  it  would  sell  a  smaller  amount.  Where 
the  size  of  plant  of  maximum  efficiency  is  large  enough  to  supply  the 
entire  market  for  any  article  or  service  (e.  g-  electric  light  in  a  city), 
monopoly  production  is  likely  to  be  the  cheapest.  (For  a  fuller 
discussion  of  the  conditions  fixing  the  rates  charged  by  a  company 
whose  facilities  are  not  completely  utilized,  see  the  author's  Principles 
of  Commerce,  New  York — Macmillan  — ,  1916,  Part  III,  Chapter  I, 
§6  of  Chapter  II,  and  §  i  of  Chapter  III.)  But  it  should  be  clear 
enough  that  where  an  increase  of  output  is  dependent  upon  the 
construction  and  maintenance  of  several  plants,  a  higher  price  is 
more  likely  to  increase  supply  than  a  lower  price. 


62  Earned  and  Unearned  Incomes. 

to  the  world's  need  of  them,  such  as  wheat,  corn, 
cotton,  iron  ore;  and  goods  more  or  less  fixed  in 
quantity,  such  as  original  Greek  statuary,  the 
paintings  of  Michael  Angelo,  and,  chief  in  impor- 
tance, land.  It  is  true  that  producers  of  wheat, 
corn  and  cotton  will  not  engage  in  the  production 
of  these  crops  at  a  price  below  cost  (in  the  sense 
and  on  the  hypotheses  herein  set  forth).  But 
the  sellers  of  land  space  do  not  have  cost  of  pro- 
duction to  consider,  because  land  space  practically 
speaking  (though  there  is  some  "made  land")  can 
not  be  produced.  The  owners  of  land  space  there- 
fore, in  selling  it,  consider  only  the  utility  to  them 
of  what  they  can  get  for  it  compared  to  the  utility 
to  them  of  the  land.  The  producer  of  cotton,  also, 
after  he  has  produced  it,  considers  only  the  utility 
of  what  he  can  get  for  it  compared  to  the 
utility  to  him  of  the  cotton — if  he  has  any  way 
of  using  it  all.  But  cotton  is  constantly  being 
used  up  and  requiring  to  be  resupplied  and 
before  producmg  it,  the  cotton  farmer  most 
certainly  will  consider  its  cost  of  production,  nor 
will  he  go  on,  year  after  year,  raising  cotton 
for    less    than    this. 

§  4 
Labor    Costs    in    Production 

Having  made  the  foregoing  general  analysis 
of  cost  of  production  and  its  influence  on  de- 
mand and  supply,  we  have  now  to  enter  into 
some  of  the  more  detailed  aspects  of  cost.  A 
larger  supply  of  any  good  (assuming  no  im- 
provements   in    methods    of    production)    involves 


Ultimate  Determinants  of  Value.        63 

either   more    labor   by   those    already    engaged    in 
producing    it    or    a    larger    number    of    such    pro- 
ducers.     Neither   can    ordinarily    be    had    without 
higher  price  as  an  inducement.     Let  us  first  con- 
sider   the    possibilities    as    regards    getting    more 
goods    of    a    given    sort    by    engaging    more    per- 
sons for  their  production.     In   much   of  our   pre- 
vious   discussion,     we    have     seemed    to    assume 
that   the   tendency,   so   far   as   change   of   employ- 
ment   is    easy,    is    for    returns    to    workers    to    be 
about    the    same    in    one    line    of    activity    as    in 
another,   in   proportion  to  effort   and   other   sacri- 
fices.     But    we    have    not    emphasized    the    fact 
that    a    given    line    of    activity    may    seem    much 
harder,     much     more     distasteful,    to    some    men 
than    to    other    men.      This    fact    may    sometimes 
have   an   important   influence   on    price.      By   way 
of     illustration,     let     us     suppose     a     change     in 
occupations    abroad     of    such     a     sort    that    far 
more   American   wheat   was   wanted   than    before, 
and    this    not    temporarily    owing    to    war    condi- 
tions but   more   or   less   constantly.      For   a   while 
this    want    might    be    very    inadequately    satisfied, 
but   should    the    demand    and    the    resultant    high 
price    continue,     larger     acreage    in     the    United 
States    would    be    sown    to    wheat,    and    a    larger 
proportion     of    the    American     population    would 
devote     themselves     to     wheat     production.       Of 
those    who    changed    from    other    lines    into    agri- 
culture,   some    would    be    persons    with    no    train- 
ing  for  the  work   and   others   persons   with   com- 
paratively little  taste  for  it.     To  make  the  large 
production    continuous,    the   price   of   wheat   must 
remain    high    enough    to    keep    these    persons    in 


64  Earned  and  Unearned  Incomes. 

the  work.  After  a  period  of  a  generation  or 
two,  new  tastes  and  habits  would  have  time 
to  form,  and  a  larger  number  of  men  than 
before  might  be  willing  to  engage  permanently 
in  agriculture  without  much  extra  inducement. 
But  during  a  short  period,  though  a  period 
of  some  years,  a  considerable  inducement  to 
wheat  production,  in  the  form  of  high  prices, 
might     be    necessary. 

There  is,  however,  in  addition,  the  possibil- 
ity of  securing  more  goods  of  a  given  sort, 
e,  g.  wheat,  by  getting  those  already  engaged 
in  its  production,  to  work  more  intensively  or 
to  work  longer  hours.  But  additional  hours 
of  labor  become  progressively  more  and  more 
a  burden  and  there  is  a  progressive  disinclina- 
tion to  perform  such  labor.  At  first  thought 
we  might  suppose  that  a  higher  rate  of  pay 
per  hour  would  encourage  working  longer  hours, 
that  a  higher  price  of  wheat,  for  instance, 
would  cause  persons  already  engaged  in  wheat 
production  to  work  longer  hours  and  thus  pro- 
duce more  wheat.  But  it  is  perhaps  equally 
likely  that  the  larger  returns  per  hour,  result- 
ing in  greater  prosperity,  would  make  the  long- 
er hours  of  labor  seem  less  necessary  as  a 
means  of  getting  a  living''  and  would  encourage 
the  taking  of  more  leisure.  So  there  is  no  cer- 
tainty that  a  higher  price  would  in  that  way 
add  to  the  supply  even  temporarily.  So  far  as 
agriculturists    could    change    from    other    lines    to 

1''  Cf.  Jevons,    T/ie   Theory   of  Political  Economy,   fourth   edition, 
London    (iMacmillan),  1911,  pp.  179-183. 


Ultimate  Determinants  of  Value.        65 

the  production  of  wheat,  a  rise  in  wheat 
prices  might  induce  them  to  do  so,  and  event- 
ually it  would  bring  more  men  into  agriculture; 
but  it  very  likely  would  not  increase  the  in- 
tensity or  the  hours  of  labor  and  it  might, 
conceivably,  even  decrease  them.  It  does  not 
follow  that  a  lower  price  would  cause  more 
wheat  to  be  produced  than  a  higher.  For 
though  smaller  returns  from  wheat  and  other 
farm  products  might  necessitate  somewhat  more 
work  to  make  a  living,  if  agriculturists  had  no 
alternative,  yet,  as  things  are,  lower  returns 
than  in  other  lines  would  divert  many  into 
these  other  lines  and  so  almost  of  necessity 
decrease  the  supply  of  agricultural  produce,^" 
just    as    higher    returns    would    draw    more    men 


^^  Even  if  a  lower  price,  e.  g.  for  wheat,  would  actually  bring  a 
larger  supply  than  a  higher  price — as  it  might  if  wheat  producers 
were  unable  to  change  their  occupation  and  simply  had  to  work 
harder  for  a  living — price  would  still  be  determined  at  the  point 
where  demand  and  supply  were  equal  and,  probably,  there  would 
be  only  one  such  point-  Any  other  price  would  mean  a  position  of 
unstable  equilibrium  and  could  not  continue-  The  high  price, 
though  it  might,  on  the  present  hypothesis,  limit  supply,  would  be 
likely  to  limit  demand  still  more.  The  low  price,  though  it  might 
increase  the  supp'y,  would  presumably  still  more  increase  the  de- 
mand. Competition  would  therefore  operate  to  fix  price  at  the  point 
of  equality.  We  are  not  here  dealing  with  a  supply  which,  at 
any  price,  is  a  certain  amount  or  indefinitely  more  (see  Fisher, 
Elementary  Principles  of  Economics,  New  York — Macmillan — ,  1912, 
PP-  317.  324)  but  with  a  supply  which,  though  it  increases  as  price 
falls,  increases,  for  each  lower  price,  only  up  to  a  certain  limit. 
Some  point  of  ecjuilibrium  there  must  be,  unless  we  suppose  supply 
to  increase  as  price  falls,  and  to  decrease  as  price  rises,  more  rapidly 
than  demand ;  and  that,  therefore,  demand  exceeds  supply  at  the 
higher  prices,  and  falls  short  of  it  at  the  lower. 


66  Earned  and  Unearned  Incomes. 

into   wheat   raising   and   increase   the    number   of 
bushels    produced. 

§   5 

Land  and  Capital  Costs  in  Production 

We  have  seen  that  to  get  a  larger  supply  of 
any  good  may  be  expected,  ordinarily,  to  require 
a  larger  amount  of  labor'.  Attention  should 
now  be  called  to  the  fact  that  it  requires  the 
use  of  more  layid  or  a  more  intensive  application 
of  labor  and  capital  to  land  already  used  for 
the  line  of  production  in  question,  or  both. 
Suppose,  as  before,  that  there  is  desired  the 
production  of  wheat.  Assuming  other  things 
to  be  equal,  more  wheat  can  not  be  produced 
unless  the  land  already  devoted  to  wheat  pro- 
duction is  cultivated  more  intensively,  unless 
additional  land  not  previously  cultivated  is 
brought  under  cultivation,  or  unless  land  pre- 
viously used  for  other  purposes  is  diverted  to 
the  production  of  wheat.  To  get  larger  wheat 
production  in  any  of  these  ways,  requires  a 
higher  price.  Assume  that  the  price  has  been 
$1  a  bushel.  At  that  price  the  average  producer 
will  cultivate  his  land  with  whatever  degree  of 
intensiveness  yields  the  greatest  gain.  He  will 
increase  the  amount  of  labor  devoted  to  cul- 
tivating his  wheat  land,  as  long  as  the  wheat 
yielded  pays  the  wages  of  this  labor  and  a  satis- 
factory return  on  the  necessary  capital.  But 
the  point  is  soon  reached  beyond  which  ad- 
ditional labor  can  not,  without  spreading  over 
more     land,     produce     wheat    enough     to    cover 


Ultimate  Determinants  of  Value.        67 

the  requisite  wages.  For  it  is  impossible,  on 
a  given  piece  of  land,  indefinitely  to  increase 
the  amount  of  labor  and  get  a  proportionately 
increased  product.  This  fact  is,  of  course,  general- 
ly known  to  farmers,  and,  in  its  applications  to 
urban  land,  is  known  to  merchants  and  manufac- 
turers also.  But  if  wheat  sells  for  $1.20  a  bushel, 
and  money  wages  remain  the  same,  or  even  advance 
somewhat,'"  it  may  be  profitable  to  cultivate  a 
given  piece  of  land  more  intensively  than  other- 
wise would  pay.  An  additional  man  may  be  hired 
and,  though  the  amount  of  Vv^heat  produced 
probably  will  not  increase  in  anything  like  the 
same  per  cent  as  the  labor,  the  increase,  at  the 
neiv  and  higher  price,  will  be  more  likely  to 
cover  the  additional  wages  paid  and  to  yield  some 
profit,  than  it  would  at  the  lower  price.  But  the 
point  to  be  emphasized  is  that,  other  things  equal, 
it  will  not  pay  thus  to  cultivate  the  land  more 
intensively  unlesn  the  price  to  be  received  is 
higher.  The  higher  price  is  a  necessary  means 
of  bringing  out  the  larger  supply. 

The  same  principle  applies  to  urban  land.  To 
increase  the  amount  of  manufacturing  or  of  retail 
trading  on  a  given  area,  necessitates  more  crowded 
quarters  or  else  higher  buildings,  and  the  higher 
buildings  are  made  the  more  solid  must  be  their 
foundations.     In  other  words,  a  point  is  eventually 

^^  To  the  objection  that  we  have  assumed  wages  virtually  to  fall 
since  we  assume  wheat  prices  to  rise  in  a  greater  degree  than 
wages,  the  answer  may  be  made  that,  if  the  prices  of  other  goods 
do  not  rise  at  all,  wages  need  not  rise  as  far  as  does  wheat  in 
order  that  wage  earners  should  be  able  to  enjoy  a  larger  amount  of 
goods-in-general  than  before- 


68  Earned  and  Unearned  Incomes. 

reached  where  additional  stories,  and,  therefore, 
additional  production  on  the  same  land  space, 
yields  a  less  reward  than  would  smaller  production, 
proportionate  to  the  labor  (including  the  labor 
of  building)    expended. 

If  all  land  had  exactly  the  same  capacities  and 
advantages,     an     additional     demand     for    wheat 
would    not    for    any    great    length    of    time    cause 
wheat  land  to  be  cultivated  any  more  intensively 
tnan    before,    as    compared    with    land    used    for 
other  purposes.     It  would  always  be  more  profit- 
able, if  a  larger  amount  of  wheat  were  wanted,  to 
divert   land   from   the   production    of   other   goods 
into  the  production  of  wheat.     But  in  fact,   land 
has    not    all    the    same    capacities.      Hence    there 
would  be  some  loss  in  turning  into  wheat  produc- 
tion land  previously  used  to  produce    (say)    corn. 
The  corn   land   is  farther  south,   on   an  average; 
and  rather  than  get  all  the  extra  wheat  desired,  by 
diverting  former  corn  land  into  wheat  production, 
it  may  be  desirable  to  get  part  of  it  oy  cultivating 
more  intensively  the  land  already  devoted  to  wheat 
raising.      But   it   is   also   true   that   an    additional 
demand  for  wheat  (or  other  goods)  is  likely  to  be 
partly  satisfied  by  diverting  into  such  production 
land  which  was  previously  otherwise  used.     This, 
of    course,    necessitates    a    higher    price    for    the 
wheat.      Let    us    suppose    that   tastes    or    customs 
have  changed  so  that  wheat  is  even  more  used  as 
food  than  now  and  corn  less  so.     Since  some   of 
the  land  used  to  produce  corn  can   also  be  used 
to  produce  wheat,  the  probability  is  that  part  of 
the   additional   wheat  wanted   will   be   so   secured. 
But  it  will  not  be  so  secured  except  at  a  higher 


Ultimate  Determinants  of  Value.        69 

relative  price  for  wheat.  Presumably  the  lands 
used  for  producing  corn  are  devote<^  to  that 
purpose  because,  at  existing  values,  it  pays  best 
so  to  devote  them.^^  But  with  wheat  higher  in 
price,  and  corn,  perhaps,  lower,  it  may  be  worth 
while  to  divert  some  land  from  the  one  use  to 
the  other.  The  use  which  was  before  less  profit- 
able, now  becomes  more  profitable  in  relation  to 
other  uses.  The  two  kinds  of  goods  are  compet- 
itive and  that  one  which  can  pay  more  for  the  use 
of  the  land,  gets  it.^^  A  change  in  relative  values 
may  give  to  a  wheat  crop,  land  which  would  other- 
wise have  been  devoted  to  corn ;  or  may,  in  a 
city,  give  to  a  shirt  factory,  land  which  would 
otherwise  be  used  for  a  shoe  factory  or  for  a 
wholesale  grocery. 

Following  our  previously  adopted  sense  of  "cost 
of  production,"  we  may  say  that  the  cost  of 
production  of  wheat  (at  the  margin  of  wheat 
production,  viz,  on  the  land  which  it  is  just  worth 
while  to  devote  to  that  purpose  instead  of  to  some 
other — or  no  other — purpose,  and  with  the  labor 
which  is  just  induced  to  follow  wheat  production) 
is  measured  by  the  value  of  the  other  goods,  e.  g. 

18  Though  it  will  also  pay,  in  many  cases,  to  alternate  or  rotate 
crops,  for  the  sake  of  retaining  fertility,  nevertheless,  a  higher  price 
of  wheat  would  introduce  it  into  rotations  from  which,  at  a  lower 
price,  it  would  be  omitted. 

18  This  idea,  suggested  by  Mill  in  a  reference  to  what  he  regards 
as  an  exceptional  case  (Principles  of  Political  Economy,  Book  III, 
Chapter  IV,  §6),  appears  to  be  clearly  understood  by  Jevons  who 
discusses  it  at  length  in  the  preface  to  the  second  edition  of  his 
Theory  of  Political  Economy,  (See  pp.  xlvii-U  of  the  fourth  edi- 
tion.) 


70  Earned  and  Unearned  Incomes. 

corn,  which  the  same  labor  and  land  might  have 
produced  instead. 

Since,  besides  land  and  labor,  machinery  and 
other  kinds  of  ''capital"  are  used  in  production, 
and  since  such  "capital"  can  only  be  accumulated 
by  saving,  we  may  regard  saving  (or  "waiting") 
as  one  of  the  three  primary  factors  of  production, 
the  other  two  being  labor  and  land.  And  we  may 
widen  our  concept  of  cost  of  production  so  as  to 
include  consideration  of  saving.  Wg  shall  then 
say  that  the  cost  of  production  of  wheat,  for 
example,  is  the  amount  of  corn  or  other  goods 
which  the  same  labor,  land  and  saving  could  pro- 
duce if  devoted  to  such  other  line  and  which 
must  therefore  be  sacrificed  if  the  wheat  is 
produced    instead. 

§    6 

The    Value    of   Land 

The  value  of  land — and  of  some  other  goods  not 
now  reproducible,  such  as  original  Greek  statuary 
— has  little  or  no  relation  to  cost  of  production. 
Land  has  no  cost  of  production  (though  there  is, 
of  course,  a  very  little  "made  land")  in  the  sense  in 
which  we  have  used  this  expression.  The  amount 
which  purchasers  will  pay  for  land  is  not, 
practically,  limited  by  any  alternative  they  may 
have  of  producing  some  of  it  themselves,  nor  is 
the  amount  that  sellers  will  take  at  all  determined 
by  any  corresponding  consideration  of  other 
rewards  which  the  labor  of  its  production  might 
have  brought  them,  since  there  is,  for  land  as 
such,   no  such  labor  of  production.     Land   has  a 


Ultimate  Determinants  of  Value.        71 

value  based  on  its  earning  power,-"  but  this  value 
is  neither  directly  nor  ultimately  fixed  by  any 
cost   of   production. 

§   7 
Joint  Demand  and  Joint  Supply 

Two  cases  of  value,  sometimes  called  special 
cases  though  really,  perhaps,  more  usual  than  the 
more  simple  case,  remain  to  be  cleared  up.  One  is 
the  case  of  joint  demand ;  the  other  is  the  case 
of  joint   supply. 

Demand  for  the  services  of  railroads  may  be 
mentioned  as  a  case  of  joint  demand.  Demand 
for  rail  transportation  involves,  indirectly,  demand 
for  rails,  ties,  ballast,  engines,  cars,  services  of 
engineers,  etc.  All  of  these  together  are  necessary 
for  transportation.  Demand  and  supply  (or,  in 
some  degree,  government  regulation)  fix  a  set  of 
rates  (prices)  for  transportation  and  these  rates 
go  out  indirectly  as  payments  for  the  various 
services  by  which  the  service  of  transportation 
is  made  possible.  If  any  one  thing  needful  for 
transportation  is  scarce,  e,  g.  ties,  the  price  of 
that  thing  may  go  very  high  indeed  without 
raising  the  price  of  transportation  (dependent  on 
so  many  prices)  in  anything  like  the  same  degree, 
and  therefore  without  greatly  diminishing  the 
demand  for  transportation.  The  different  articles 
and  services  included  in  joint  demand  may  change 
greatly  in  price  relatively  to  each  other,  according 
to  their  relative  costs  of  production,  without  chang- 


20 


Cf.    Chapter   VI,    §2. 


72         Earned  and  Unearned  Incomes. 

ing  the  price  of  or  the  demand  for  the  desired 
combined  service.-^ 

Joint  supply  is  the  familiar  case  of  by-products. 
Two  or  more  things  are  in  part  produced  by  the 
same  process.  Thus,  coke  and  coal  gas  are  both 
produced  by  the  process  of  abstracting  gas  from 
coal.  The  expense  of  mining  the  coal  and  the 
expense  of  abstracting  the  gas  are  then  joint 
expenses.  These  expenses  would  have  to  be  met 
either  to  get  the  coal  gas  or  to  secure  the  coke. 
Another  example,  commonly  given,  is  that  of  wool 
and  mutton.  These  are  joint  products  of  the 
sheep  raising  industry.  The  expense  of  sheep 
raising  is  a  joint  expense,  an  expense  which  must 
be  met  to  secure  either  the  wool  or  the  mutton, 
but  which,  if  it  is  met,  makes  it  possible  without 
great  additional  cost,  to  get  both  wool  and  mutton. 
In  this  case,  as  in  most  cases  of  joint  supply  or 
joint  cost,  not  all  of  the  cost  is  joint.  The  cost 
of  shearing  is  not  joint  but  is  necessary  only 
to  get  the  wool.  The  cost  of  slaughtering  is 
necessary  to  get  the  mutton.  The  expenses  of 
marketing  are  also,  for  the  most  part,  special. 
But  a  considerable  part  of  the  total  expense  is 
joint. 

In  tlie  case  of  joint  supply,  a  part  of  the  expense 
of  production,  i.  e.  the  part  which  is  joint,  will 
be  covered  in  varying  proportions  in  the  price  of 
the   several   goods   so  produced,   according  to  the 

21  Cf.  Marshal!,  Principles  of  Economics,  sixth  edition,  London 
(Macmillan),  1910,  pp.  381-383,  and  Taussig,  Principles  of  Econo- 
mics, second  edition,  New  York  (Macmillan),  1915,  Vol.  I,  pp.  221- 
224. 


Ultimate  Determinants  of  Value.        73 

relative  demand  for  such  goods.-'-  The  producers 
must,  in  the  long  run,  receive,  from  all  the  goods 
jointly  produced,  the  average  return  on  the  labor 
and  capital  applied  to  production  of  such  goods. 
But  any  one  of  the  by-products  may,  if  demand 
for  it  is  small,  sell  for  little  more  than  enough  to 
cover  the  special  expense  of  producing  and 
marketing  it.  Thus,  in  the  case  of  wool  and 
mutton,  the  prices  received  for  both  must  cover 
the  cost  of  marketing,  slaughtering  and  shearing,  as 
well  as  the  cost  of  maintaining  the  flocks;  but  the 
price  received  for  the  wool  alone,  in  case  the 
demand  for  wool  is  relatively  small — or  for  the 
mutton  alone,  if  the  demand  for  it  is  small — need 
cover  little  more  than  the  special  cost  of  produc- 
ing and  marketing  the  one  product,  leaving  the 
purchasers  of  the  other  to  pay  the  part  of  the 
cost  which  is  joint.  In  consequence  of  this  fact, 
an  increased  demand  for  mutton  would  tend  to 
lower  the  price  of  wool.  For  it  would  encourage 
sheep  raising  and  would  thus  increase  the  amount 
of  wool.  But  the  larger  amount  of  wool  could 
not  be  sold  (for  we  are  not  assuming  a  greater 
demand  for  it)  except  at  a  lower  price.  Hence, 
the  price  would  fall,  and,  since  the  process  of 
producing  the  mutton  involves,  also,  the  prelim- 
inary step  of  producing  the  wool,  it  would  be  worth 
while  to  sell  the  wool  for  the  cost  of  shearing  and 
marketing,  rather  than  not  sell  it  at  all.-^ 

22  See  J.  S.  Mill,  Principles  of  Political  Economy,  Book  III, 
Chapter  XVI,  §i. 

23  For  a  discussion  of  whether  railroad  rates  are  -an  example  of 
joint  cost,  see  the  author's  Principles  of  Commerce,  New  York  (Mac- 
millan),  1916,  Part  III,  p.  9,  footnote. 


74         Earned  and  Unearned  Incomes. 

§  8 
Summary 

In  this  chapter  we  have  endeavored  to  trace  the 
influences  bearing  upon  value  and  price  back  to 
their  more  remote  origins.  Since  supply  of  one 
good  means  demand  for  others,  it  appeared  that 
there  could  not  be  a  general  oversupply  of  all 
goods  but  that  an  oversupply  of  some  means 
merely  a  relative  undersupply  of  others.  Demand 
for  any  good  involves  a  willingness  to  sacrifice 
something  in  order  to  get  it.  The  sacrifice  may 
take  the  form  of  extra  effort  or  of  giving  up 
some  alternative  good.  At  any  price  the  demand 
of  each  purchaser  is  for  so  much  of  the  good  that 
another  unit  of  it  would  be  worth  no  more  than 
the  price  paid  in  money,  and,  therefore,  in  labor 
or  in  other  goods.  A  high  price  of  any  article 
would  tend  to  reduce  demand  for  it  not  only  by 
discouraging  its  consumption  but  also  by  causing 
many  who  would  else  be  purchasers  of  it  to 
become  instead  producers  of  it.  In  this  sense, 
demand  for  any  good  depends  upon  its  cost  of 
production.  Purchasers  will  not,  in  the  long  run, 
pay  more  for  a  good  than  the  amount  of  other 
goods  which  the  same  productive  effort  and  other 
sacrifice  will  produce.  The  prices  at  which  there 
may  be  demand  for  a  non-reproducible  good, 
are  not  thus  limited. 

The  supply  of  any  good  depends  upon  the  price 
offered,  and  upon  the  intensity  of  demand  of  the 
producers  of  it  for  the  other  goods  they  indirectly 
get  through  its  sale.  A  higher  price  will  not  of 
necessity  always  cause  producers  to  work  longer  or 


Ultimate  Determinants  of  Value.        Y5 

harder  at  their  task.  It  may  encourage  them  to 
reduce  their  hours  of  work  since  it  may  enable 
them  to  earn  more  than  before  in  fewer  hours 
than  before.  But  a  higher  price  will  usually  in- 
crease the  amount  of  any  good  produced  since  it 
will  usually  increase  the  number  of  persons  pro- 
ducing that  good  by  diverting  some  from  other 
lines.  Supply,  therefore,  depends  upon  cost  of 
production  except,  of  course,  in  the  case  of  non- 
reproducible  goods,  of  which,  with  some  qualifica- 
tion, land  space  is  an  example.  To  get  more  of 
anything  produced  may  require  a  higher  price 
because  persons  relatively  ill  adapted  to  its  pro- 
duction or  to  whom  the  work  is  comparatively 
distasteful  must  be  drawn  in,  because  poorer 
land  must  be  used,  because  land  already  so  used 
must  be  used  more  intensively,  and  because  land 
relatively  better  fitted  (at  the  old  relation  of 
prices)  for  other  production  must  be  drawn  in. 
The  cost  of  production  of  any  good  comes 
finally  to  be  expressible  as  the  amount  of  some 
other  good  or  goods  which  the  same  labor,  land 
and  saving  could  produce.  The  cases  of  joint 
demand  and  joint  supply  were  found  to  involve 
some  intricacies  but  no  new  fundamental  principle. 


CHAPTER  III 
THE  CAUSES  OF  INTEREST 

§  1 
The   Factors   of  Production 

The  factors  of  production  may  be  said  to  be 
land,  labor  and  capital.^  Some  writers  mention 
business  leadership  as  a  fourth  factor,  but  this 
since  it  involves  mental  effort  and  requires  direct- 
ing ability,  may  properly  enough  be  regarded  as 
a  kind  of  labor.  Other  writers  class  land  with 
capital,  but  we  have  already  found  reasons  to 
consider  land  separately  from  goods  produced  by 
mankind,-  and  shall  have  reason  further  to  press 
the  distinction,  later  on.^ 

Let  us  now  consider  what  fixes  the  amount  of 
each  factor  of  production.  As  to  land,  little  need 
be  said.  Its  amount  is  practically  fixed  by  nature. 
There  is,  to  be  sure,  some  "made  land."  The 
people  of  Holland  have  dyked  back  the  North  Sea 
and  made  cultivable  a  considerable  area  which 
would  otherwise  be  largely  under  water.  There 
are  doubtless  other  cases  where  land  is  "made" 
by  human  effort,  though  not  on  so  large  a  scale. 
But  it  is  nevertheless  almost  absolutely  true  that 

1  Since  capital  depends  upon  productive  effort  plus  saving,  the 
ultimate  factors  are  land,  labor  and  saving  (or  waiting).  Cf. 
Senior,  Outlines  of  the  Science  of  Political  Economy,  fifth  edition, 
pp.  58-60. 

2  Chapter  II,  §§2,  3  and  6. 

3  Chapter  IV,  §§  3  and  5. 

(76) 


The  Causes  of  Interest  77 

the  amount  of  land  space  in  existence  is  fixed  by 
nature  and  cannot,  practically,  be  changed  by  man. 
The  barrier  to  increase  of  available  land  space 
is  not  absolute.  It  is  conceivable,  for  example, 
that  shallow  parts  of  the  ocean  might  be  filled 
in  by  dredging  sediment  from  other  shallow  parts. 
But  the  expense  would  almost  invariably  be 
prohibitive,  certainly  in  relation  to  the  expected 
gain.  In  other  words  the  (marginal)  cost  of 
production  of  land,  if  it  were  necessary  to  produce 
much  of  it  in  the  way  suggested,  would  be  tre- 
mendously high,  and  land  would  have  to  get  tre- 
mendously scarce  and  high  in  value  before  it 
would  be  worth  while  so  to  produce  it  to  any 
appreciable  extent.  The  value  of  land  space, 
therefore,  as  pointed  out  in  the  last  chapter,* 
cannot  be  said  to  depend  in  any  marked  degree, 
if  at  all,  on  the  cost  of  production  of  land.  Nor 
can  the  amount  of  land  space  in  existence  be  said 
to  depend  on  the  amount  for  which  land  will  sell 
or  upon  the  profits  which  land  ownership  yields. 
Thus  land  space  diff"ers  from  most  other  goods  in 
the  relative  fixity  of  supply,  for  a  higher  value  of 
other  goods  or  a  higher  profit  from  their  use,  or 
a  greater  efficiency  of  labor,  may  affect  the  supply 
of  such  goods  considerably.  Though  land  fertility 
may  be  increased  by  labor,  land  space  practically 
cannot   be.      So   far   as   the    fertility   of    land    is 

*§6.  For  further  discussion  and  elaboration  nf  tlie  various  points 
of  difference  between  land  and  capital,  and  for  critical  considera- 
tion of  views  inconsistent  with  that  presented  in  this  book,  see 
Chapter  IV,   §§3    and  5,   and   Chapter  VI,   §§i,   2,   3   and   8. 


78  Earned  and  Unearned  Incomes. 

given  by  nature  and  is  not,  practically  speaking, 
dependent  on  the  efforts  of  man  for  its  mainte- 
nance, we  shall  class  it  with  land  space  as  a 
part  of  the  factor  land.  So  far  as  it  is  a  produced 
fertility,  we  shall  regard  it  as  capital. 

§   2 
The  Accumulation  of  Capital 

Land  may  be  regarded,  in  a  sense,  as  one  of  the 
tools  man  has  to  work  with,  a  tool  furnished  by 
nature.  Man's  other  tools,  though  drawn  from  the 
land,  are  furnished,  in  a  sense,  by  himself.  He 
constructs  them  and  fits  them  to  suit  his  needs. 
With  these  tools  we  should  include  such  improve- 
ments on  the  land  as  foresting,  draining,  fertiliz- 
ing, fencing,  clearing,  leveling,  etc.,  as  well  as  the 
buildings  placed  upon  the  land.  All  of  these  things 
can  be  increased  by  human  effort  and  are  not 
fixed  in  quantity  in  the  same  degree  as  land. 

Among  the  things  produced  by  men,  it  is  neces- 
sary to  distinguish  those  made  for  personal 
pleasure  or  practically  immediate  consumption 
and  those  made  as  steps  towards  future  consump- 
tion, such  as  accumulated  stocks  of  goods,  build- 
ings, tools  and  machinery,  etc.  The  former  we 
call  consumptive  goods,  and  the  latter  we  call 
capital.  While  it  may  be  hard  to  determine,  in 
some  borderline  cases,  to  which  class  certain 
things  belong,  the  general  distinction  is  sufficiently 
clear  for  use  in  our  further  discussions. 

What  determines  the  extent  to  which  such 
capital  will  be  accumulated?  Several  influences 
are    important.      First,    may    be    mentioned    the 


The  Causes  of  Interest  79 

efficiency  of  production.  In  a  community  where 
wealth  is  easily  produced,  a  large  amount  can  be 
accumulated  with  less  deprivation  of  immediate 
wants  than  if  productive  effort  were  less  efficient. 
Rich  natural  resources,  well-trained  and  intelligent 
labor,  high  capacity  for  work,  all  tend  to  facilitate 
accumulation.  And  the  fact  that  accumulation 
has  taken  place  in  the  past  and  that,  as  a  conse- 
quence, the  community  has  more  and  better 
machinery'  of  production,  certainly  tends  to  make 
productive  effort  more  effective  and  so  to  make 
further    accumulation    easier. 

In  the  second  place,  the  amount  of  capital  de- 
pends upon  personal  characteristics  of  the  members 
of  a  community,  upon  the  extent  to  which  they 
desire  to  save  and  are  willing  or  anxious  to  deny 
themselves  present  gratifications  for  the  sake  of 
the  future  of  themselves  or  their  children,  or  other 
dependents.'' 

§   3 

The  Productivity  of  Capital 

We  are  now  ready  to  begin  our  discussion  of  the 
distribution  to  different  economic  classes,  of  what 
the  industrial  and  commercial  processes  produce 
for  human  use  and  consumption.  First  among 
the  shares  received,  we  may  consider  the  interest 
on  accumulated  capital.  This  has  been  said  by 
some  writers  to  be  due  to  the  productiveness  or 

^  Perhaps  the  best  statement  of  the  influences  that  lead  to  and 
that  retard  accumulation  is  to  be  found  in  Fisher,  T/ie  Rate  of 
Interest,  New  York  (Macmillan),  1907,  Chapter  VI.  John  Rae, 
Bohm-Bawerk    and   others   have    also    developed    this   subject. 


80  Earned  and  Unearned  Incomes. 

productivity  of  capital,  and  by  others  to  be  a 
consequence  of  the  fact  that  to  get  an  accumula- 
tion of  capital  there  must  be  a  degree  of  absti- 
nence practiced  or  that  an  inducement  must  be 
offered  to  get  men  to  sacrifice  present  consump- 
tion for  future.  Let  us  examine  these  alleged 
causes  of  interest  with  a  view  to  determining 
what  their  significance  may  be  for  our  problem. 
That  capital  is  productive  in  the  sense  that  we 
can  get  more  with  it  than  without  it,  is  generally 
recognized.  It  is  recognized  simply  because 
experience  indicates  that  it  is  a  fact  and  not  by 
virtue  of  a  priori  reasonings.  And  experience 
indicates  it  to  be  a  fact,  not  in  the  sense  that 
every  possible  mode  of  production  with  capital 
is  more  effective  than  production  without  it,  but 
only  in  the  sense  that,  given  any  stage  of  knowledge 
of  how  to  use  capital,  production  is  more  efficient 
if  we  can  get  a  certain  amount  of  capital  to  use 
in  the  understood  ivays  than  if  we  can  not.  No 
one  would  seriously  contend  that  every  use  of 
machinery  or  other  capital  was  advantageous. 
It  is  entirely  probable  that  we  often  use 
valuable  (in  the  sense  of  having  high  cost)  and 
complicated  machinery  to  do  work  that  could  be 
as  effectively  done  without  it  or  to  do  work  not 
worth  doing.  We  construct  buildings  of  stone  in 
places  which  are  soon  deserted  and  where,  there- 
fore, frame  buildings — though  less  enduring — 
would  be  more  economical.  And  where  we  do  use 
capital  advantageously,  it  often  is  true  that  an 
attempt  to  use  it  on  a  much  greater  scale  would 
not  be  worth  while.  To  lengthen  the  production 
process  by  introducing  more  steps  is  not  desirable 


The  Causes  of  Interest  81 

without  limit.  The  thought  will  perhaps  occur 
to  the  reader,  not  only  that  capitalistic  or  "round- 
about"^ production  processes  either  may  or  may 
not  be  advantageous,  but  also  that  if  those  which 
we  use  are,  for  the  most  part,  advantageous,  this 
is  because  we. would  not  intentionally  use  them  if 
they  were  not.  On  the  hypothesis  that  present 
pleasures  are  always  preferred  to  future  ones  and 
future  discomforts  to  present  ones,  this  view  is 
justified.  But  it  might  easily  be  the  case  that  a 
person  or  group  of  persons  would  rather  do  work 
today  which  should  find  its  fruition  years  hence 
when  needs  are  great  and  strength  is  small  than 
to  do  the  work  now  for  a  like  present  reward,  or 
later  for  a  later  reward.'  We  cannot  definitely 
assert,  therefore,  that  a  long  time  process  of 
production,  involving  the  making  of  machinery  or 
the  planting  of  trees  or  some  other  early  labor  as 
an  intermediate  step  to  getting  a  future  product, 
would  never  be  chosen  in  preference  to  a  short 
time  process,  unless  there  were  an  advantage  in 
choosing  it  from  the  point  of  view  of  a  larger 
total  product.  Often  we  might  find  advantage 
enough  from  saving,  in  having  nature  ofl'er  us  the 
opportunity  to  store  up  labor — which  it  happens 
to  be  convenient  for  us  to  undergo  today — until 
a  future  when  its  product  is  more  needed."    Never- 

"  Bohm-Bawerk's  expression.  See  The  Positive  Theory  of  Capital, 
English  Translation,  London  (Macmillan) ,  1891,  or  Positive  Theorie 
des  Kapitales,  Dritte  Auflage,  (Innsbruck),  1912. 

''  Cf.  Carver,  The  Disiributiofi  of  Jl'ealth,  New  York  (Mac- 
millan), 1904,  pp.  232,  233. 

®  But  unless  there  were  a  gain  from  thus  investing,  the  average 
person   would   probably   simply   hoard    some   indestructible    form    of 


82  Earned  and  Unearned  Incomes. 

theless,  although  some  kinds  of  capitalistic  pro- 
duction may  not  profit  us,  and  although  we  might 
be  willing  to  produce  capitalistically  to  some 
extent  without  getting  a  consequent  larger  return ; 
yet  that  we  usually  do,  in  practice,  secure  a  much 
larger  product  with  the  use  of  capital  than  we 
could  secure  without  it,  is  a  conclusion  resting  on 
hardly-to-be-denied  experience.  And  so  long  as 
we  can  find  ways  of  thus  producing  capitalistically 
which  are  gainful,  i.  e.  which  yield  us  more  than 
the  same  effort  would  yield  if  a  part  of  the  effort 
applied  were  not  first  devoted  to  capital  formation, 
we  are  not  likely  to  waste  our  time  in  the  many 
(perhaps)  possible  ways  of  capitalistic  production 
vrhich  do  not  yield  a  gain.^ 

In  connection  with  our  argument  that  capital 
makes  production  more  effective,  the  qualification 
should  be  made  that  this  principle  applies  as 
logically  to  the  production  of  noxious  drugs, 
burglar's  tools  and  other  socially  undesirable 
articles  or  services,  as  to  the  production  of 
socially  desirable  goods.  Capital  becomes  altogether 
beneficent  only  if  all  possible  anti-social  uses  of  it 
are  prohibited.  Again,  roundabout  or  capitalistic 
production  must  be  held  to  include  activities 
other  than  the  construction  of  what  is  ordinarily 
called  material  equipment.  It  includes  activities 
which   work   out   their  long  runs   effects   through 

wealth  such  as  gold.  Possibly  an  iron-clad  government  guarantee  of 
the  return  of  each  person's  capital  in  any  form  on  demand  would  be 
equally  as  satisfactory  as  hoarding,  to  some. 

^  This  is  not  to  deny  that  we  will  use  capital  to  keep  (store)  the 
products  of  one  season  for  use  in  another,  though  the  capital  so 
used  increases  only  utilities  and  not  material  goods. 


The  Causes  of  Interest  83 

changes  wrought  in  men's  minds.  Thus,  it  may  be 
regarded  as  including  education  pursued  for  the 
purpose  of  increasing  one's  earning  power.  It 
includes  also  such  activities  as  the  bribery  of 
public  officials  and  the  attempt,  by  misleading 
public  sentiment  and  by  building  up  political 
machines,  to  get  thereby,  for  those  pursuing  such 
policies,  profitable  contracts  and  other  advantages 
in  the  future,  at  public  expense.  A  business  con- 
cern which,  by  thus  taking  measures  and  making 
expenditures  to  secure  for  itself  the  opportunity 
of  getting  profitable  if  dishonorable  business,  has, 
so  far  as  its  purposes  are  concerned,  increased  its 
capital  as  much  as  if  it  had  increased  its  invest- 
ment in  buildings  or  machinery  and  is,  from  its 
point  of  view,  engaged  in  roundabout  or  capital- 
istic production. 

It  is  to  be  emphasized  that  capitalistic  produc- 
tion is  time-using  production.  Instead  of  plucking, 
as  we  need  it,  the  wild  grain,  and  so  keeping  an 
interval  of  but  minutes  or  even  seconds  between 
efl'ort  and  the  satisfaction  of  needs,  we  sow  or 
plant  the  grain  months  before  we  expect  to  reap  it; 
we  build  barns  which — though  we  may  soon 
begin  to  use  them — we  shall  not  have  finished 
using,  perhaps,  at  the  end  of  half  a  century ;  we 
manufacture  plows,  harrows  and  reapers  which 
will  not  yield  us,  for  many  years,  all  that  it  is  in 
them  eventually  to  yield ;  we  construct  factories 
for  the  manufacture  of  these  implements,  factories 
which,  when  their  builders  have  long  since  ceased 
to  build,  will  still  be  turning  out  implements  of 
agriculture  for  long  continued  future  use ;  we 
build  bridges,   lay  tracks,   erect  stations  and   con- 


84  Earned  and  Unearned  Incomes. 

struct  locomotives,  any  or  all  of  which  can  not, 
ordinarily,  yield  us  this  year  or  next  an  advantage 
at  all  comparable  to  their  cost — i.  e.  to  the 
advantage  which  our  effort  might  have  brought  if 
devoted  to  the  satisfaction  of  more  immediate 
needs — but  which,  in  the  long  run,  pay  for  them- 
selves often  several  times  over.  In  all  of  these 
cases  we  interpolate  a  long  period  of  time  between 
the  putting  forth  of  effort  and  the  receiving  of  its 
entire  product,  though  in  some  of  the  cases  a 
small  part  of  the  resulting  product  is  enjoyed 
early. 

Production  may  be  made  more  capitalistic  by 
increasing  the  length  of  time  of  waiting  between 
effort  and  enjoyment  of  the  results  of  effort,  or  by 
increasing  the  proportionate  amount  of  effort 
(more  accurately,  perhaps,  by  increasing  the 
proportionate  amount  of  labor,  of  land,  and  of 
available  tools)  which  is  directed  to  remote  instead 
of  comparatively  immediate  ends.  In  either  case 
there  w^ould  be  an  increase  in  the  average  time, 
all  work  considered,  between  the  putting  forth  of 
effort  and  the  receiving  of  its  fruits.  Thus,  the 
time  elapsing  between  effort  and  the  receiving  of 
the  entire  reward  of  the  effort  is  increased  when, 
instead  of  making  frame  buildings  for  factories, 
we  construct  the  factories  of  structural  steel.  The 
buildings  are  more  permanent;  a  longer  time 
elapses  before  they  have  rendered  all  the  service 
of  which  they  are  capable.  But  we  also  increase 
the  roundaboutness  of  production  if,  without 
lengthening  the  production  period  for  any  one 
factory,  we  divert  a  part  of  our  labor  force, 
previously  occupied  in  utilizing  existing  equipment, 


The  Causes  of  Interest.  85 

into  the  work  of  building  an  additional  factory. 
It  may  easily  be  that  all  of  the  labor  employed  in 
(say)  shoe  production  could  be  employed  in  keep- 
ing up  and  in  operating  the  existing  factories  and 
machinery;  and  that  nevertheless  production  would 
be  larger  if  some  of  this  labor  was  used  for  the 
building  of  another  factory,  since  thus  there 
would  be  more  space  and  larger  equipment  per 
operator.  Such  diverting  of  a  part  of  shoe-pro- 
ducing effort  to  the  addition  of  shoe-producing 
equipment  would  be,  no  less  than  to  make  equip- 
ment more  durable,  an  increase  in  the  round- 
aboutness  of  production. 

So,  also,  the  diverting  of  coal  mines  which  had 
been  used  for  the  production  of  coal  to  run  the 
machinery  of  an  existing  shoe  factory,  into  the 
production  of  coal  for  the  smelting  of  iron  and 
for  the  making  of  structural  steel  to  be  used  in 
building  an  additiorial  shoe  factory,  would  mean  a 
use  of  the  coal  mines,  as  well  as  of  the  labor  of  the 
operators,  in  a  more  roundabout  way  than  before. 
Again,  the  diverting  of  land  from  use  as  pastures 
and  for  the  production  of  hides  to  be  used  in  shoe 
making,  into  forest  growing  and  the  production  of 
lumber  for  the  building  of  shoe  factories  would 
be,  in  respect  to  such  land,  an  extension  of  the 
roundaboutness  of  production.  Such  a  change  to 
greater  roundaboutness  in  the  production  on 
exceptionally  well  located  (or  otherwise  good) 
land  would  be  likely  to  mean  a  larger  change  in 
the    degree     of    roundaboutness    of    production^" 

i°It  is,  of  course,  assumed  at  this  point,  that  the  land  in  question 
is  reasonably  well  adapted  to  either  use. 


86  Earned  and  Unearned  Incomes. 

than  a  corresponding  shift  in  the  kind  of  produc- 
tion to  which  inferior  land  is  put.  Still  again, 
the  productive  use  of  both  land  (the  site)  and 
capital  (the  building)  is  made  more  roundabout  if 
a  factory  intended  for  the  manufacturing  of  shoes 
is  used  for  the  making  of  shoe  manufacturing 
machinery.  Any  parts  of  the  product  which  may 
be  attributable  to  the  land  or  to  the  capital  as 
well  as  what  is  attributable  directly  to  labor, 
then  take  more  largely  the  form  of  capital  or  in- 
struments of  further  production  than  before  and 
less  largely  the  form  of  consumption  goods. 

There  seems,  however,  little  point  to  speaking 
of  capital  (i.  e.  produced  equipment  goods)  as 
being  diverted  to  greater  or  less  roundaboutness 
in  production  since  capital  is  itself  but  a  stage  in 
the  roundabout  application  of  labor  applied  to 
natural  resources.  Capital  is  an  intermediate  good 
and  a  derivative  of  more  ultimate  factors.  To  di- 
vert capital  to  more  roundabout  production  is  really 
to  bring  it  about  that  the  original  labor  of  con- 
structing this  capital  was  more  largely  roundabout 
than  it  otherwise  would  have  been  and  that  the 
land  space  utilized  in  the  process  of  its  production 
was  also  devoted  to  the  securing  of  more  remote 
ends.  Let  us  conclude,  then,  that  the  roundabout- 
ness of  production  is  increased  when  labor  is  di- 
verted from  less  to  more  roundabout  processes  and 
that  this  change  is  greater  when  the  labor  is  work- 
ing on  sites  which  yield  a  surplus  or  rent  above 
wages,"   since  this   surplus  then,   as   well   as   the 


^^  Providing,  of  course,  that  a  surplus  is  produced  when  the  land 
fs  devoted  to  the  more  roundabout  process. 


The  Causes  of  Interest.  87 

(marginal)    product  of  labor,   takes   the   form   of 
production   goods. 

The  roundaboutness  of  production  has  been  in- 
creased, to  use  another  illustration,  by  the  building 
of  railroads.  Let  us  suppose  two  towns,  A  and  B, 
200  miles  apart.  In  the  absence  of  better  means 
of  transport,  goods  are  carried  from  the  one  town 
to  the  other  and  different  goods  returned  in  trade, 
by  men  acting  as  carriers.  It  takes,  let  us  say,  a 
week,  for  twenty  men  to  carry  a  ton  of  goods  from 
A  to  B.  Omitting,  for  the  present,  considerations 
regarding  the  raising  or  manufacture  of  these 
goods,  we  may  say  that  only  a  Vv^eek  of  labor  pre- 
cedes the  consumption  of  the  goods  and  only  two 
weeks  precedes  a  complete  trade  and  the  con- 
sequent consumption  aimed  at  by  the  people  in 
both  towns.  And  all  of  the  benefits  towards  which 
the  two  weeks  of  labor  were  directed  follow  with 
relative  quickness  the  putting  forth  of  the  effort. 
If,  however,  instead  of  carrying  the  goods  on  their 
backs,  the  carriers  make  carts  or  wagons  and 
domesticate  animals  to  draw  these,  their  ac- 
complishments may  be  much  greater;  but  the 
period  during  which  these  accomplishments  are 
realized  will  be,  in  relation  to  the  period  of  effort, 
more  deferred  than  before.  A  wagon  may,  indeed, 
be  made  in  a  week's  time  and  by  the  end  of  another 
week  it  may  have  carried  more  goods  between  the 
two  to^vns  than  the  maker  could  carry,  without  it, 
in  a  month  or  more.  But  the  wagon  will  not,  in  a 
week,  be  worn  out.  On  the  contrary,  it  will  pre- 
sumably be  in  condition  for  use  during  many  later 
weeks  through  all  of  which  the  service  rendered 
by  it  is  largely  a  result  of  the  labor  put  forth  in 


88  Earned  and  Unearned  Incomes 

making  it.  The  rewards  of  that  labor  (of  making 
the  wagon)  are,  therefore,  on  the  average,  more 
deferred  than  the  rewards  of  the  labor  of  carrying 
when  wagons  were  not  used.  Suppose,  next,  that 
a  railway  is  built  between  the  towns.  The  build- 
ing requires  three  years,  during  most  of  which 
period  the  rails  can  not  be  used  to  carry  goods. 
At  the  end  of  the  three  years,  the  possible  trade 
may  be,  indeed,  much  greater  than  before  and  the 
carriage  of  goods  swifter;  but  the  labor  of  build- 
ing the  railroad  will  still  be  contributing  to  com- 
munity welfare  long  after  those  who  built  the 
road  have  ceased  to  be  able  to  lift  a  spade  or  carry 
a  tie.  Surely  the  length  of  time  elapsing  between 
effort  and  the  totality  of  the  reward  of  that  effort, 
or  even  the  earlier  half  of  the  reward  of  that 
effort,  has  been  tremendously  increased.  By  no 
means  all  improvements  in  the  processes  of  pro- 
duction are  of  the  time-lengthening  character.  But 
it  does  appear  to  be  true  that  many  of  them  are 
so.  Our  orchards,  our  irrigated  farms,  our  stone- 
paved  streets  and  concrete  sidewalks,  our  buildings 
of  structural  steel,  our  complicated  machines  of 
steel  and  iron,  our  railroads,  and  our  great  steel 
ocean-going  vessels, — all  involved  for  their  con- 
struction labor  the  fruits  of  which  are  not  enjoyed 
in  full  until  long  years  beyond  the  time  when  the 
labor  was  put  forth. 


The  Causes  of  Interest  89 

§  4 

Capital    Accinnidation    versus    Marginal    Capital 

Productiveness 

But  although  the  more  roundabout  processes  of 
production    seem    to    be — at   least,    those   that   we 
actually    do    follow — clearly    advantageous    to    us, 
yet  our  gain  seems  to  be  proportionately  smaller 
as  we  thus  utilize  proportionately  larger  amounts 
of  labor.     To  add  to  the   community's   equipment 
a  certain  number  of  railroads,  buildings,  machines, 
fruit   orchards,   etc.,   may   add   immensely   to   the 
product  we  can  hope  to  realize  from  our  efforts, 
while  a  further  amount  of  labor  devoted   to   the 
still  greater  increase  of  such  equipment  would  be 
of  diminishing  advantage,  and  a  still  further  de- 
voting of  time  to  such  a  purpose  of  yet  smaller 
benefit.     A  single  railroad  between  New  York  and 
Chicago  is  tremendously  advantageous  as  compared 
with  none  at  all.     A  second   railroad   may  be   of 
great  importance  but  is  less  nearly  indispensible. 
A  third  and  a  fourth  may  be  desirable  enough  to  be 
worth  building.     But  there  comes  a  point  of  rela- 
tive sufficiency  of  such  railroads,  beyond  which  it 
pays  better  to  devote  our  labor  to  other  purposes. 
Again,  while  it  may  be  far  better  to  have  one 
or  more  railroads  between  two  points  than  not  to 
have  them,  there  will  be,  perhaps,  a  less  propor- 
tionate gain  from  the  added  expenditure  necessary 
to  make  the  lines  relatively  straight.     It  is  much 
better  to  have  a  winding  road  than  no  road  at  all. 
A  straight  and  level  road  might  involve  tunneling 
through    mountains    and    the   bridging    of    gulleys 


90  Earned  and  Unearned  Incomes 

and  might  be,  therefore,  immensely  more  expen- 
sive in  initial  cost;  while  yet  it  might,  eventually, 
be  labor  saving.  In  other  vi^ords,  a  given  large 
amount  of  effort  is  likely  eventually  to  accomplish 
more  if  the  straight  road  is  built.  But  the  per 
cent  gain  may  diminish  with  each  such  improve- 
ment. 

The  addition  of  stock,  buildings  and  machinery 
to  a  farm  reaches,  in  time,  a  point  beyond  which 
it  is  not  worth  while  to  go.  A  barn  may  seem 
almost  indispensable.  That  more  time  should 
be  devoted  to  its  building,  making  it  larger,  or 
that  two  barns  should  be  built,  may  be  desirable 
for  the  sake  of  having  a  protected  space  for 
the  bumper  crops  of  exceptional  years;  but  a 
second  barn  is  of  much  less  importance  than  a 
first  and  may  be  said  to  bring  a  diminishing 
advantage.  Even  the  fact  that  part  of  such  a 
crop  must  be  stacked  may  not  be  a  sufficient  reason 
for  the  building  of  the  larger  or  the  second  barn, 
in  view  of  alternative  opportunities  for  the  em- 
ployment of  the  necessary  labor.  Likewise,  a 
mowing  machine,  though  requiring  more  initial 
labor  to  make  and,  therefore,  a  much  higher 
price  to  buy,  is  immensely  to  be  preferred  to 
several  scythes.  A  second  mowing  machine  is 
of  less  advantage  though  the  gain  from  having 
it  also  may  be  considerable.  Sometimes  the 
possession  of  the  second  machine  may  make 
possible  the  getting  in  of  a  crop  during  a  short 
sunny  period,  or  the  use  of  a  team  which  cannot, 
for  a  few  days,  be  otherwise  used  to  advantage; 
or  the  second  machine  may  temporarily  be  the  sole 
resource  if  the  first  happens  to  be,  for  any  rea- 
son,  out  of  commission.     The  gain   from   a  third 


The  Causes  of  Interest.  91 

machine  would  be  negligible  and  from  a  fourth 
there  would  perhaps  be  no  gain  at  all.  Again, 
to  take  another  illustration  from  agriculture, 
the  grain  product  which  a  given  amount  of  labor 
can  secure,  will  be  greater  if  cradles  are  used  for 
reaping  than  if  sickles  are  used,  and  very  much 
greater  if  a  reaping  machine  is  used.  Or  we 
may  say  that  a  given  grain  product  can  be  realized 
from  a  given  land  area  with  a  smaller  expenditure 
of  labor  when  the  improved  machinery  is  used 
than  when  reaping  is  done  with  the  tools  of  an 
earlier  generation.  And  still  further  gain,  though 
perhaps  less  gain  proportionally,  is  realized  from 
the  use  of  modern  reapers  which  bind  the  grain 
as  well  as  cut  it.  Nevertheless,  there  is  un- 
doubtedly a  limit,  though  perhaps  an  elastic  one, 
as  to  both  quantity  and  quality  of  machinery, 
beyond  which  it  is  not  worth  while  to  pass. 

But  if,  in  any  community,  only  a  limited 
amount  of  effort  (as  well  as  of  land  and  equip- 
ment already  available)  can  be  devoted  to  thv^ 
construction  of  equipment  for  production,  con- 
sideration must  be  given  to  the  fact  that  some 
equipment  is  more  important  than  other.  The 
farmer  can  get  along  without  a  reaper  better 
than  without  a  barn.  He  can  get  along  without 
a  silo  better  than  without  a  reaper.  The  railroad 
can  get  along  without  stations  or  with  inadequate 
stations  better  than  it  can  get  along  without  a 
track,  engines  and  cars.  The  city  can  get  along 
without  stone  paving  on  its  streets  better  than 
it  can  get  along  without  any  streets  at  all.^- 

^2  It  is  not  at  all  obvious  as  Cassel   appears  to  suggest  that  it  Is 
(The  Nature  and  Necessity  of  Interest,  London — Macmillan — ,1903, 


92         Earned  and  Unearned  Incomes. 

We  conclude,  then,  that  the  gains  from  round- 
about production  tend  to  diminish  as  such  pro- 
duction is  extended,  and  tend  to  diminish  whether 
the  extension  of  roundaboutness  takes  the  form 
of  the  addition  of  equipment  beyond  the  most 
necessary  kinds,  or  of  an  additional  amount  of 
equipment  of  all  kinds,  or  of  more  expensive 
quality  of  equipment.  In  fact,  when  the  amount 
of  effort,  land  and  tools  available  for  the  pro- 
duction or  maintenance  of  desirable  capital  equip- 
ment is  greatly  limited,  the  effect  is  likely  to  be 
as  apparent  in  the  making  of  poorer  and  cheaper 
equipment  as  in  a  diminution  in  the  number  of 
equipment   implements."     The  reason   is   that  the 

pp.  31  and  55)  that  the  diminishing  return  to  capital  as  capital  is 
increased,  is  related  to  the  law  of  dimishing  returns  from  land. 
It  is  true  enough  that  as  the  application  of  labor  to  land  increases, 
after  the  point  of  diminishing  returns  is  reached,  the  returns  yielded 
to  the  further  applications  of  labor  become  relatively  smaller,  and 
this  is  doubtless  equally  the  fact  whether  the  labor  is  directly  or 
indirectly  (i.  e.  by  first  being  devoted  to  capital  making)  applied. 
But  it  does  not  follow  that  the  net  per  cent  gain  of  roundabout 
over  direct  production  will  be  any  less  because  population  is  large 
in  relation  to  natural  resources  and  because  the  returns  to  both 
roundabout  and  direct  production  are  therefore  small.  To  express 
differently  the  same  thought,  if  the  value  of  capital  is  measured  by 
the  other  goods  which  the  capital-forming  labor  (and  other  factors 
of  production)  could  have  produced  as  an  alternative,  the  per  cent 
return  on  this  value  is  not  necessarily  any  lower  because  of  a  lower 
margin  of  production  on  land.  The  correct  opinion  appears  to  be 
clearly  stated  by  Jevons,  The  Theory  of  Political  Economy,  fourth 
edition,  London  (Macmillan),  1911,  p-  255;  Cf.  also  p.  314  (Ap- 
pendix III ) . 

^3  This  view  is  clearly  held  by  J-  B.  Clark  although  he  seems  not 
to  have  thought  it  necessary  to  present  the  argumentative  defense 
of  it  which  follows  above.  See  The  Distribution  of  Wealth,  New 
York  (Macmillan),  1899,  pp.  174-177. 


The  Causes  of  Interest.  93 

competition  of  employers  for  the  use  of  equipment 
will  result  in  relatively  poor  equipment  for  the 
use  of  nearly  all  labor  rather  than  in  splendid 
equipment  for  some  labor  and  none  at  all  for  the 
rest.  A  small  amount  of  the  poor  equipment 
yields  greater  advantages  to  those  enterprisers 
who  would  otherwise  have  none — and  they  can 
therefore  bid  higher  for  it — than  a  corresponding 
addition  to  the  quality  of  their  equipment  would 
yield  to  employers  who  might  be  especially  favored 
with  the  more  costly  buildings,  machinery,  etc., 
but  who  could  not,  because  of  the  limited  amount 
of  this  capital,  employ  all  the  community's  avail- 
able labor.  In  other  words,  although  the  more 
costly  equipment  would  presumably  be  more  durable 
or  otherwise  superior,  yet  if  the  necessary  labor 
of  its  construction  would  be  so  great  as  to  mean 
an  inadequate  7iumher  of  implements  for  the  labor 
force  of  the  community,  the  bidding  for  the  use 
of  capital  of  those  who  might  otherwise  have  none, 
would  prevent  putting  all  available  capital  value 
into  the  more  durable  or  otherwise  more  expensive 
form.  Let  us  suppose  a  community  for  the  use 
of  which  an  amount  of  capital  is  available  large 
enough  to  house  all  its  industries  in  frame  build- 
ings but  sufficient  to  house  only  half  of  them  in 
buildings  of  structural  steel  and  concrete.  Though 
the  more  substantial  buildings  would  perhaps 
have  a  potential  life  more  than  twice  as  long,  yet, 
in  vietv  of  the  assumed  existing  situation,  it  would 
not  be  desirable  to  choose  them.  The  extra  invest- 
ment of  labor  that  would  have  to  be  made  to  con- 
struct a  given  building  in  the  more  substantial 
way,   could  be  used  to  get  a   second   of  the  less 


94  Earned  and  Unearned  Incomes. 

substantial  buildings  along  with  the  first;  and 
this  would  be  the  more  worth  while  investment, 
until  the  community  became  richer  and  could 
spare  labor  from  other  activities  to  construct  a 
relative  sufficiency  of  the  more  expensive  build- 
ings.^*    An   additional   cheap   building  would   add 

^*  J.  B.  Clark,  criticizing  Bohm-Bawerk,  says  {The  Distribution 
of  IVealth,  New  York — Macmillan — ,1900,  p.  138)  that  adding  to  the 
length  of  the  production  periods  "does  not  necessarily  add  to  the 
amount  of  capital  in  existence,"  that,  if  it  does  not,  "the  increase  in 
the  average  length  of  the  periods  does  not  have  the  effect  that  the 
brilliant  Austrian  economist  attributes  to  this  lengthening,  for  it  does 
not  reduce  the  rate  of  interest"  which  might  "be  high  when  the 
periods  were  long  and  low  when  they  were  short"  and  that  it  is 
"when  the  quantity  of  permanent  capital  increases  that  interest  falls." 

Professor  Clark's  theory,  however,  is  more  easily  to  be  reconciled 
with  that  of  Bohm-Bawerk  than  he  appears  to  realize.  In  the  first 
place,  a  lengthening  of  production  periods  distinctly  tends  towards 
an  increase  of  the  amount  of  capital.  Consider  the  case  of  a  man 
who  is  about  to  work  for  100  consecutive  days.  If  the  average  period 
of  production  is  short,  he  may  spend  5  days  in  making  a  capital  in- 
strument which  yields  its  services  during  the  next  5  days  during 
which  the  man  is  producing  another  to  take  its  place,  and  so  on 
throughout  the  100  days.  There  will,  then,  at  no  time  be  more  than 
5  days  of  labor  stored  up  as  capital.  But  the  production  period 
may  be  much  longer.  Thus,  it  may  require  50  days  to  make  an  in- 
strument which  yields  its  services  during  the  next  50,  during  which 
it  is  replaced.  In  this  case,  although  no  more  days  than  in  the  other 
are  devoted  to  capital  production,  there  is  always — after  the  first 
50  days — 50  days  of  labor  stored  up  in  capital.  The  amount  of 
capital  in  existence  at  any  one  time  is  much  larger.  (Elsewhere 
— pp-  293-295 — Clark  himself  recognizes  this  principle.)  Assum- 
ing the  amount  of  saving  done  in  a  community  to  be  such  as  to  cause 
many  to  engage  in  such  longer  production  processes  and  assuming 
that  the  increased  length  of  period  does  not  correspondingly  increase 
the  product,  we  should  have  to  conclude  that  the  rate  of  interest  would 
be  lower. 

In  the  second  place,  it  is  just  because  an  indefinite  increase  in  the 
length   of  the  production  periods  will   not  correspondingly   increase 


The  Causes  of  Interest.  95 

much  more  to  the  efficiency  of  labor  in  such  a 
community  than  greater  durability  of  a  building 
certain  to  be  constructed  in  any  case.  Hence  an 
employer  of  labor  would  prefer  to  use  what  capital 
he  could  get,  in  the  former  way.  Hence,  also, 
prospective  borrowers  of  capital  desiring  to  use 
it  in  the  former  way  could  afford  to  pay  more  for 
its  use. 

It  should  be  emphasized  that  the  use  of  capital 
does  not  necessarily  mean  a  progressively  larger 
product,  does  not  mean,  for  instance,  a  larger 
product  next  year  than  this.     All  it  means   is  a 

the  returns  to  labor,  that  so  much  labor  is  devoted  as  is  devoted,  to 
the  production  of  the  shorter-lived  capital  instruments  and  that  the 
marginal  productivity  of  these  shorter-lived  instruments  is  reduced 
to  a  comparatively  low  return-  Suppose  the  average  production 
period  to  be  a  year  and  capital  to  yield,  at  the  margin,  lo  per  cent. 
Increased  saving  might,  by  increasing  capital,  reduce  the  marginal 
gain  from  using  it  to  (say)  8  per  cent.  But  if  it  should  meanwhile 
appear  that  these  savings  could  be  used  in  a  three-year  roundabout 
process  yielding  at  the  rate  of  lo  per  cent  a  year  or  33.1  per  cent 
(compounding)  for  the  three  years,  the  one-year  instruments  would 
be  less  constructed  and  would  become  comparatively  scarce.  Hence 
their  marginal  product  would  become  as  great  as  10  per  cent  and 
interest  would  become  10  per  cent.  If  however,  the  lengthening  of 
the  production  period  would  not  correspondingly  increase  the  pro- 
duct, this  lengthening  would  be  less  resorted  to  and  mere  one-year 
instruments  would  be  constructed.  Hence,  interest  might  fall  to 
9  or  8  per  cent.  Even,  therefore,  if  we  were  to  regard  increased 
length  of  production  periods  as  not  involving  any  increase  of  capi- 
tal more  than  would  be  involved  in  devoting,  the  same  labor  to  the 
production  of  short-time  capital  instruments,  and  even  if  we  were 
to  regard  the  rate  of  interest  as  being  fixed  directly  by  the  marginal 
productivity  of  these  short-time  instruments,  the  possibilities  of  re- 
sorting to  roundabout  production  would  still  have  to  be  taken  ac- 
count of  as  conditions  determining  the  amount  of  short-time  capital 
that  would  be  constructed. 


96  Earned  and  Unearned  Incomes. 

larger  product  next  year  than  next  year's  product 
would  be  if  capital  were  not  used.  We  may  choose 
to  produce  capitalistically  up  to  and  not  beyond  a 
certain  limit.  If  we  so  choose,  we  may  go  on, 
year  after  year,  producing  the  same  amount  of 
wealth  and  maintaining  an  unchanging  standard  of 
living,  but  getting,  each  year,  more  than  we  could 
get  with  corresponding  effort,  were  our  methods 
of  production  less  capitalistic. 

§   5 

Saving  or  Abstinence  in  Relation  to  Interest 

In  order  that  the  more  productive  roundabout 
process  may  be  followed,  there  must  be  saving. 
For  the  roundabout  process  means,  as  we  have 
seen,"  productive  effort  the  full  reward  of  which 
is  greatly  deferred.  The  labor  of  building  a  rail- 
road must  be  fairly  well  completed  before  the 
resultant  services  can  begin,  and  not  for  many 
years  are  these  efforts  rewarded  with  all  the 
services  towards  which  they  were  directed.  Y2t 
the  persons  who  build  the  railroad  must  have  food 
and  clothing  while  they  are  at  work.  In  like 
manner,  the  labor  of  building  a  factory  for  the 
making  of  agricultural  machinery  may  be  an 
initial  step  in  the  securing  of  wheat  and,  therefore, 
in  the  securing  of  bread.  The  persons  who  per- 
form this  labor  must  have  food  and  presumably, 
bread,  yet  the  labor  does  not  immediately  produce 
bread.  There  must  be  bread  at  hand,  or  securable 
by  the  builders  during  the  period  of  their  building, 
else  the  work  can  not  go  on. 

1=  §3  of  this  Chapter    (III). 


The  Causes  of  Interest.  97 

The  fact  that  subsistence  must  be  available  to 
make  possible  the  prosecution  of  roundabout 
production  may  mean  and  probably  does  mean  that 
there  are  at  hand  accumulations  from  the  past. 
These  accumulations  will  not  be  mainly,  perhaps, 
stores  of  wheat,  etc.,  from  the  last  harvest 
(although  in  winter  and  spring  such  stores  must 
be  considerable)  so  much  as  accumulations  of 
machinery,  draft  animals  and  buildings  which 
facilitate  production  of  wheat,  etc.,  as  needed. 
But  whether  roundabout  production  necessitates 
past  saving  or  not,  it  certainly  necessitates  saving. 
The  saving  may  be  present  saving  of  other 
members  or  classes  of  the  community.  Thus,  the 
building  of  a  factory  for  the  manufacture  of  farm 
implements  may  be  possible  because  the  producers 
of  wheat  are  raising  more  wheat  than  they  can 
use,  saving  a  part  of  the  money  derived  from  the 
sale,  and  investing  this  money  in  a  company 
organized  to  manufacture  agricultural  machinery. 

It  will  be  advantageous  to  trace  out  in  greater 
detail  the  interrelations  of  savers  (who  may  or 
may  not  be  laborers)  and  the  laborers  employed 
by  the  savings.  The  wheat  raisers  (assuming  them 
to  do  the  saving)  produce  wheat  in  excess  of  their 
own  needs;  they  sell  this  excess  on  the  market 
and  it  becomes  a  part  of  the  stock^*'  of  U3able 
wealth  of  the  community.  The  money  they  receive 
may  be  regarded  as  so  many  tickets  entitling  them 
to  draw  from  this  stock  a  value  equal  to  what 
they  have  put  in.     But  they  do  not  spend  all  of 

^•'The  concept  here  is  that  of  a  stock  of  wealth  which  is  contin- 
ually being  drawn   from   and   replenished. 


98         Earned  and  Unearned  Incomes. 

this  money  in  withdrawing  consumption  goods. 
A  part  of  the  money  is  saved.  The  saved  money  is 
invested  in  the  stock  or  bonds  of  the  agricultural 
machinery  company  (either  directly  or  through  the 
intermediation  of  a  broker  or  a  savings  bank) .  The 
company  then  uses  this  money  to  hire  labor  to  build 
its  factory.  The  laborers  employed  to  build,  in 
spending  their  money  for  bread  and  other  necessary 
or  desired  goods,  are  taking  from  society's  stock  and 
using  up,  the  goods  which  the  saved  money  repre- 
sented.^^ While  doing  this,  however,  they  have  pro- 
duced a  factory.^^  Therefore  the  persons  who  did 
the  saving  and  investing  now  have  ownership  in 
the  factory  instead  of  having  had  and  enjoyed  the 
other  wealth  which  they  might  by  now  have 
consumed,  had  they  chosen  the  alternative  of  not 
saving. 

The  same  principle  applies  if,  instead  of  adding 
new  capital,  the  savers  merely  keep  up  the  old 
capital.     Thus,   the   owner   of   a   shoe   factory    is 

i^On  the  h\'pothesis  that  the  saved  money  is  hoarded  and  not 
spent,  prices  will  tend  to  fall,  all  the  goods  which  the  saved  money 
represents  may  be  consumed  by  others  than  the  savers  or  their  (in- 
direct) employees,  these  others  being  able  to  buy  more  goods  be- 
cause prices  are  lower,  and  the  stock  of  goods  in  society  will  not  be 
increased  by  the  saving.  Then  if,  years  after,  the  savers  or  their 
descendants  endeavor  to  expend  this  money,  prices  will  rise  and 
the  consumption  of  others  will  be  curtailed.  Those  who  have  saved 
or  their  descendants  or  those  for  whose  capital-producin^j  labor  they 
are  paying,  will  consequently  be  securing  consumable  goods,  not  so 
much  in  direct  exchange  for  the  goods  originally  supplied  by  the 
savers  to  the  social  stock,  as  at  the  expense  of  other  consumers 
of  a  later  generation,  at  the  expense  of  consumers  who  were  not 
benefited  by  the  original  saving-  (Cf.  Davenport,  Economics  of 
Enterprise,  New  York — Macmillan — ,  1913,  pp.  338,  339). 

18  See  Mill,  Principles  of  Political  Economy,  Book  I,  Chapter  V,  §5. 


The  Causes  of  Interest.  99 

supposed  to  get  from  it,  during  its  life,  besides 
interest  on  its  value,  enough  to  replace  it  when 
it  is  too  old  for  further  use.  But  this  involves 
saving  of  a  replacement  fund  instead  of  spending 
for  current  enjoyment  the  entire  receipts  from  the 
factory.  In  like  manner  the  machines  used  are 
supposed  to  yield,  on  an  average,  enough  to  re- 
place their  value  when  they  are  worn  out  or  when 
improvements  necessitate  scrapping  them.  A  part 
of  the  shoes  produced  may  be  assumed  to  be  used, 
directly  or  through  their  equivalents  in  other 
goods,  to  maintain  the  labor  occupied  in  factory 
and  machine  replacement.  The  situation  is  not 
essentially  dissimilar  when  the  owner  of  the 
machines  decides  to  shift  his  investment.  He  then 
does  not  replace  these  machines  but  uses  their 
earnings  in  a  corresponding  way  to  provide  for 
the  construction  of  a  different  kind  of  machines 
or  of  some  other  form  of  capital,  having  uses  of 
another  sort.  Past  accumulations,  then,  with  the 
exception  of  stocks  of  consumable  goods  which, 
because  of  the  requirements  of  convenience  or 
because  of  the  seasonal  character  of  their  produc- 
tion, must  be  kept  on  hand,  take  largely  such 
forms  as  buildings,  roads  and  streets,  railroads, 
bridges  and  ships,  and  machinery.  (They  also 
take,  in  part,  the  form  of  political  connections 
and  other  means  of  exploitation.)'^  The  labor  which 
is  engaged  in  maintaining  or  in  adding  to  any  of 
this  equipment  is  supported  the  more  adequately 
because  the  accumulations  of  capital  already  made 
render  industry  more  effective.     Nevertheless,  the 

"See  §3  of  this  Chapter  (III). 


100        Earned  and  Unearned  Incomes. 

support  of  this  labor  comes  immediately,  in  large 
part,  from  current  product.-"  And  the  keeping  of 
some  labor  thus  occupied  in  maintaining  or  in 
Increasing  equipment  means  that  a  part  of  economic 
society  is  devoting  a  part  of  its  purchasing  power 
to  such  ends  instead  of  consuming  as  much  as  its 
possession — or  receipt  of  purchasing  power — would 
enable  it  to  consume. 

The  discussion  of  saving  and  investing  has  thus 
far  seemed  to  establish  the  conclusion  that  savings 
take   form    as    equipment   goods   by   being   turned 
over  to  laborers  who,  while  consuming  goods  of  the 
value   of  the  sums   saved,   are  at  the  same   time 
producing    equipment.      But    the    amounts    saved 
and  thus  devoted  to  the  production  of  production 
goods,    are   not    paid    over    solely   to    laborers    as 
wages.     They  are  also  paid  over,  in  part,  to  land- 
oivners  as  rent  for  the  use  of  land  applied  to  the 
production  of  capital,  and  to  the  owners  of  capital 
now  in  existence,  as  interest,  in  payment  for  the 
use   of   this    capital    in    the   production    of    other 
capital.     In  short,  the  surplus  production  of  goods 
which   we   have   spoken   of   as   savings,   is   turned 
over  to  those  ivho  otvn  or   (in     the  case  of  their 
own  labor)  apply  the  various  factors  of  production 
and  may  be  entirely  consumed  by  these   persons; 
but  in  due  time  there  issues  from  the  cooperation 
of  these  factors  a  stock  of  equipment  goods  of  a 
value  equal  to  the  value  of  the  savings  consumed. 
It  appears,  then,  that  roundabout  production  is 
gainful  but  that  it  involves  provision  of  consumable 

20  Cf.  Henry  George,  Progress  and  Poverty,  Book  I,  Chapters  III 
and  IV. 


The  Causes  of  Interest.  101 

goods  to  those  who  are  engaged  in  (whose  labor 
or  whose  property  is  devoted  to)  such  production. 
This  means  that  the  persons  who  provide  present 
goods  for  the  consumption  of  those  engaged  in 
roundabout  production  must  themselves  defer  or 
forego,  in  some  degree,  present  consumption.  They 
must  "abstain"  from  consuming  all  that  they 
might  consume.  Hence,  abstaining  or  abstineiice^'^ 
has  been  regarded  as  an  element  in  capital  con- 
struction, as  a  factor  which  must  be  taken  account 
of  in  a  theory  of  interest.  It  is  to  be  recognized, 
of  course,  that  a  part  of  this  abstinence  may  be 
undergone  by  the  persons  themselves  who  are 
engaged  in  roundabout  production  instead  of  by 
others  who  pay  them,  in  which  case  those  engaged 
in  roundabout  production  come  to  be,  to  that 
extent,  the  owners  of  the  capital  they  produce 
and  claimants  on  its  future  yield.  Evidently 
enough,  addition  to  the  capital  equipment  of 
society  requires  abstinence  somewhere,  and  evi- 
dently, too,  the  mere  maintaining  of  existing 
equipment,  by  replacing  capital  which  wears  out, 
involves  abstinence  from  the  consumption  which 
might  be  enjoyed  were  such  replacing  not  done. 

Whether  and  how  far  the  necessity  of  abstinence 
operates  as  a  cause  of  interest  must  depend  upon 
the  extent  to  which  it  acts  as  a  barrier  to  saving. 
If  most  of  the  people  in  the  world — or  in  a 
relatively  isolated  community — were  to  abstain 
willingly  from  present  consumption,  devoting  nearly 
all  their  productive  effort  to  capital  formation,  the 

21  See  Senior,   Outlines   of  the  Science  of  Political  Economy,  fifth 
edition,  pp.   58-60. 


102        Earned  and  Unearned  Incomes. 

supply  of  machinery  and  other  capital  would  be 
large,  the  g-ain  from  further  increase  of  it  would 
presumably  be  small,  and  the  rate  of  interest 
would  be  low.  The  theorists  who  have  endeavored 
to  explain  interest  by  reference  to  abstinence  have 
regarded  abstinence  as  a  sacrifice  to  induce  which 
a  payment  must  be  made.  They  have  not  attempted 
to  deny  that  some  saving  would  be  done  even  with 
no  interest  payment  and,  in  some  cases,  have 
taken  pains  to  assert  that  a  certain  amount  of 
saving  would  nevertheless  be  done."  But  they 
have  urged  that  such  saving  is  not  enough  to 
furnish  all  the  capital  that  can  be  profitably  used 
and  that  other  capital  can  only  be  had  by  virtue  of 
the  receipt  or  expected  receipt  of  a  return  upon 
it.-^  The  "marginal"  saver  will  not  save  unless 
compensated  for  so  doing,  and  a  man  who  would 
save  something  without  interest  will  not  save  so 
much,  will  not  save  the  "marginal"'-*  dollar  unless 
remunerated.  When  a  person  has  already  saved 
a  considerable  sum,  has  already  denied  himself 
a  considerable  amount  of  present  income  for  the 
sake  of  larger  future  income,  the  better  relative 
provision   for  his  future   than   otherwise   and   the 

22  See,  for  instance,  Carver,  The  Distribution  of  Wealth,  New 
York    (Macmillan),  1904,  pp.  232,  233. 

23  Ibid,  pp.  235-245.  Bohm-Bawerk,  misinterpreting  Carver,  makes 
the  latter  say  that  interest  is  the  result  of  overendowment  of  the 
future  (saving).  See  Recent  Literature  on  Interest,  translated  by 
Professors  Scott  and  Feilbogen,  New  York  (Macmillan),  1903,  pp. 
56-62. 

2*  "Marginal,"  above,  means  marginal  when  interest  is  paid. 
There  would,  of  course,  without  interest  or  with  it,  be  a  margin  of 
indifference,  and  hence  a  marginal  saver  and  a  marginal  dollar 
saved.     But  the  margins  would  be  different. 


The  Causes  of  Interest  103 

poorer  relative  provision  for  present  needs  will 
tend  to  discourage  further  savings  and  to  dis- 
courage them  the  more  the  greater  are  the  savings 
which  he  has  already  made.  As  Professor  Irving 
Fisher  would  put  it,  the  time  shape  of  his  income 
stream  (whether  falling,  level  or  rising)  affects 
the  individual's  attitude  towards  saving,  affects 
his  degree  of  "impatience.""  The  millionaire 
does  not  have  to  practice  abstinence,  in  the  sense 
of  making  a  sacrifice,  to  save  large  amounts.  But 
marginal  savings  do  involve  sacrifice  and  will  not 
be  made  without  compensation.  Interest,  in  this 
view,  results  from  a  shortage  of  savings,  due  to 
the  fact  that  saving  means  sacrifice  of  present  de- 
sires. We  need  not,  here,  defend  the  thesis  that 
this  sacrifice  means  "pain-cost."  It  suffices  that 
there  is  a  mental  state  which  interferes  with 
saving.  In  the  fear  that  the  word  "abstinence" 
might  connote  pain-cost,  some  economists  have 
preferred  such  terms  as  "waiting,"  "time-prefer- 
ence," or  "impatience."  The  only  essential  fact 
for  the  purpose-*' — if  it  be  a  fact — is  that  when  the 
choice  is  made  between  spending  and  saving,  the 
saver — at  least  some  savers  for  some  of  their 
saving — would  choose  to  spend  were  it  not  for  the 
interest.      The    disinclination    to    save,    so    far    as 

25  Fisher,  The  Rate  of  Interest,  New  York  (Macmillan) ,  1907,  pp. 
95-98.  Professor  Fisher,  however,  will  admit  the  abstinence  theory 
only  if  abstinence  be  not  regarded  as  a  cost   (Ibid,  pp.  43-52). 

28  It  is,  however,  interesting  to  note  that  Bohm-Bawerk,  criticizing 
Marshall,  and  endeavoring  to  imagine  a  case  in  which  there  could 
be  no  "sacrifice"  of  abstinence,  succeeded  in  imagining  one  in  which 
the  only  possible  comparison  was  of  present  labor  and  future  com- 
modity-    See  Recent  Literature  on  Interest,  pp.  41  and  42,  footnote. 


104        Earned  and  Unearned  Incomes 

there  is  such  a  disinclination,  can  be  in  large  part 
accounted  for  by  the  fact  that,  when  choosing 
between  present  and  future  expenditures,  the 
moment  of  choice  is  the  present.  When  the  future 
becomes  the  present  and  the  observation  of  the 
two  (if  two)  significant  dates  is  made  backwards 
in  time,  it  may  well  be  that  there  will  appear  to 
have  been  a  "sacrifice"  made  if  and  when  earlier 
consumption  was  preferred  to  later  (now  present 
consumption),  even  though  such  a  choice  seemed 
the  desirable  one  when  made.  If,  today,  it  causes 
regret — though  it  may  not  always  do  so — to  plan 
for  next  year's  instead  of  today's  enjoyment,  so, 
when  next  year  becomes  this  year,  it  may  cause 
us  regret  to  realize  that  we  chose  to  have  our 
enjoyment  last  year  and,  therefore,  can  not  have 
it  now. 

We  should  not  hastily  conclude,  however,  if  and 
because  there  are  some  who  will  not  save  except 
at  a  high  interest  that  high  interest  has,  in  > 
general,  the  result  of  stimulating  saving.  That  it 
does  have  this  result  has  commonly  been  assumed 
by  economists  and  is  not  here  denied,  but  the 
certainty  of  its  doing  so  is  nevertheless  to  be 
questioned.  There  are  undoubtedly  some  persons 
who  would  save  more  at  a  rather  low  rate  of 
return  on  capital  than  at  a  somewhat  higher 
rate.2^  Let  us  consider  the  case  of  a  man  who 
wishes  to  leave  to  his  descendants  an  income  of 
$5,000  a  year,  which,  in  his  view,  will  be  sufficient 
to  their  needs.  If  interest  is  10  per  cent,  an 
accumulated   capital   of   $50,000   will   be    sufficient 

2^  See  Cassel,   The  Nature  and  Necessity  of  Interest,  pp.  146-148. 


The  Causes  of  Interest  105 

for  his  purpose.  But  if  interest  is  5  per  cent,  it 
will  be  necessary  for  him  to  save  $100,000  in  order 
to  leave  the  desired  income  to  his  family  without 
the  necessity  of  their  at  any  time  trenching  on 
the  capital.-^*  He  might  actually  save  $70,000  and 
have  to  expect  some  using  up,  by  his  family,  of  the 
saved   funds. 

That  more  saving  would  result  or  that  as  much 
saving  would  result  from  lower  interest  as  from 
higher  seems,  however,  not  probable.  In  the 
first  place,  it  is  fairly  likely  that  a  person  who 
would  save  $100,000  when  interest  was  5  per  cent, 
that  his  family  might  have  a  $5,000  income  would 
save  more  than  $50,000  if  interest  were  10%, 
considering  the  extra  income  which  his  family 
might  thus  secure  as  more  than  compensating  the 
smaller  relative  sacrifice.  Reversing  the  form  of 
statement,  we  may  say  that  few  persons  probably 
would,  because  of  a  lower  interest  rate,  save  an 
enough  larger  sum  to  yield  the  same  annual  in- 
come as  they  would  expect  to  provide  if  the  rate 
of  interest  were  higher.  There  is,  indeed,  reason 
to  doubt  whether  the  average  person  would  save 
as  much  in  expectation  of  low  interest  as  if  there 
were  prospects  of  large  gains  from  the  saving. 
Saving  for  old  age  and  the  saving  which  is  done 

28  It  should  be  unnecessary  to  point  out  that,  even  if  this  attitude 
were  general,  there  would  be  a  limit  to  the  amount  actually  saved, 
and  a  rate  of  interest  w'ould  result  dependent  upon  the  relation 
between  the  advantages  of  the  use  of  capital  and  the  disposition  (or 
lack  of  disposition)  to  save.  Though  the  supply  curve  of  capital 
or  waiting  should  slope  backward,  there  would  still,  presumably, 
be  some  point  of  intersection  with  the  demand  curve,  at  which  point 
interest  would   be  determined. 


106        Earned  and  Unearned  Incomes. 

through  life  insurance  companies,  would  yield 
less  return  on  the  same  investment.  But  let  us 
consider  the  usually  larger  savings  of  those  who 
endeavor  to  provide  for  their  families  permanent 
funded  incomes.  Will  this  type  of  saving  not 
be  discouraged?  If  we  assume  as  an  extreme 
limit  a  zero  rate  of  interest,  we  have  an  hypothesis 
of  a  condition  under  which  no  return  would  be 
yielded  on  anything  less  than  an  infinite  sum 
saved. -'•'  With  no  funded  income  within  the 
realm  of  the  attainable,  might  not  some  who  now 
save  large  amounts,  give  up  the  idea  of  funded 
family  fortunes,  and  live  for  the  pleasures  of 
each  passing  day?  And  in  lesser  degree  might  not 
a  very  low  return,  say  1  per  cent,  have  a  corre- 
sponding kind  of  effect? 

In  the  second  place,  the  possibility  of  interest 
being  realized  carries  with  it  a  sort  of  selection. 
Those  who  have  the  disposition  to  save  soon  find 
themselves  realizing  interest  on  their  savings 
and  thereby  acquire  additional  ability  to  save. 
Those  who  have  not  the  disposition  to  save  are 
less  likely  to  gain  additional  ability  to  save.  The 
higher  interest  becomes,  the  more  saving  can  be 
done  by  those  who  wish  to  save,  and  this  fact 
suggests  the  likelihood  of  greater  aggregate  saving 
at  higher  interest  than  at  lower.^" 

28  Mathematical  processes  give  zero  times  infinity  as  indeterminate. 

8°  Some  one  may  reply  that  a  higher  interest  means  less  capital, 
a  lower  productivity  and  hence  lower  wages,  with  decreased  saving 
power  of  wage  earners,  even  of  wage  earners  who  are  most  ambitious 
to  save.  But  such  an  argument  would  entirely  miss  the  point-  The 
discussion  above  in  the  text  has  to  do  with  the  effect  of  interest  on 
saving  and  calls  attention  to  the  fact  that,  other  things  equal,  higher 


The  Causes  of  Interest.  107 

In  concluding  this  discussion  it  may  not  be 
amiss  to  call  attention  to  the  fact  that  the  condi- 
tions necessary  to  induce  saving  might  be  very 
different  in  a  socialist  society  in  which  private 
ownership  of  the  means  of  production  was  pro- 
hibited than  in  an  individualistic  society.  If 
saving  is  to  take  place  in  a  democratically  govern- 
ed socialistic  society,  it  is  necessary  that  a 
majority  be  in  favor  of  it.  They  must  be  willing 
that  part  of  the  society's  current  labor  shall  be 
devoted  to  the  production  of  equipment  for 
future  needs  even  though  the  volume  of  goods 
available  for  current  consumption  is  thus  lessened. 
Where,  on  the  other  hand,  saving  is  done  by 
individuals,  there  will  be  some  saving  even  if  only 
one  person  out  of  ten  or  one  person  out  of  a 
hundred  is  willing  to  defer  consumption. 

interest  means  more  saving  in  so  far  as  it  may  add  to  the  saving 
power  of  those  who  have  the  saving  disposition.  The  criticism  in 
question — if  made — approaches  the  relations  discussed,  not  from 
the  direction  of  the  effect  of  interest  on  saving,  but  from  the  direc- 
tion of  the  effect  of  saving  on  interest.  It  assumes  that  the  high  in- 
terest which  is,  in  the  text,  spoken  of  as  probably  a  cause  of 
saving,  is  a  result  of  lack  of  saving  and  therefore  of  lack  of  cap- 
ital; whereas  for  the  problem  under  discussion  the  high  interest 
which  stimulates  saving  must  be  held  to  result  from  inventions  or 
some  other  interest-raising  cause  not  connected  with  a  dearth  of 
saving. 

It  may  be  admitted,  in  passing,  that  those  who  save  are  not  al- 
ways doing  the  wise  thing  nor  those  who  spend,  the  foolish  thing. 
Saving  which  is  at  the  expense  of  good  food,  fresh  air  or  rest,  may 
diminish  a  man's  working  efficiency  by  more  than  the  interest  or 
earnings  of  the  capital  saved.  It  may,  in  some  cases,  make  future 
saving  more  difficult  than  if  the  first  saving  had  not  been  done-  But 
we  should  hardly  conclude  that  the  great  bulk  of  sums  saved  in- 
volve such  offsetting  losses. 


108        Earned  and  Unearned  Incomes. 

§   6 
Summary 

In  this  chapter  our  endeavor  has  been  to  dis- 
cover the  ultimate  causes  of  interest,  without, 
however,  attempting  an  explanation  of  how  these 
forces  cooperate  or  how  the  exact  rate  of  interest 
is  determined.  By  way  of  preliminary,  the  factors 
of  production  were  said  to  be  land,  labor  and 
capital.  We  chose  to  include  the  work  of  the 
entrepreneur  or  enterpriser  in  the  category  of 
labor.  Capital,  it  appeared  in  the  course  of  the 
chapter,  is  not  an  ultimate  factor  of  production 
but  can  be  resolved  into  other  factors.  If  we  so 
resolve  it,  our  ultimate  factors  are  land,  labor  and 
waiting  (or  saving).  The  owner  of  land  receives 
rent,  the  owner  of  capital  receives  interest  (the 
return  on  waiting  or  saving),  the  laborer  receives 
wages. 

Capital  is  produced  by  labor  applied  to  or  on 
land,  usually  with  the  assistance  of  previously 
produced  capital.  Analysis  showed  that  the 
advantage  of  using  capital  in  production  is  really 
an  advantage  of  applying  available  factors  of 
production  in  a  longer-time  rather  than  a  shorter- 
time  process.  Since  capital  is  a  derivative  factor, 
we  may,  bearing  in  mind  that  labor  is  applied  to  or 
in  cooperation  with  land,  say  that  the  advantage 
of  using  capital  is  an  advantage  of  applying 
labor  so  as  to  bring  a  relatively  remote  reward 
as  compared  with  applying  it  so  as  to  secure  a 
relatively  early  reward.  Greater  roundaboutness 
of  production  may  mean  the  lapse  of  a  greater 
period  of  time  between  effort  and  the  enjoyment 


The  Causes  of  Interest.  109 

of  its  results  or  it  may  mean  an  increase  of  the 
proportionate  amounts  of  effort  and  of  land  the 
use  of  which  is  directed  to  securing  comparatively 
distant  gains. 

It  should  be  again  emphasized,  at  this  point, 
that  capitalistic  production  is  not  always  socially 
beneficial  production  and  that  capital  is  not  always 
material  technological  equipment.  The  production 
of  adulterated  foods  may  be  carried  on  capitalistic- 
ally.  And  not  only  well-deserved  goodwill,  but 
also  public  favor  due  to  sedulously  propagated 
misinformation  and  governmental  encouragement 
due  to  selfish  political  activity  or  even  to  bribery, 
may  constitute  part  of  a  concern's  capital.  The 
seeking  of  such  favor  or  encouragement  means 
engaging  in  roundabout  production.  Nevertheless, 
though  capitalistic  processes  may  he  anti-social 
and  the  returns  received  may  be  therefore  un- 
earned, it  does  not  follow  that  such  must  he  the 
case.  In  an  ideal  economic  society,  all  such  anti- 
social methods  of  wealth  getting  would  be  effect- 
ively prohibited  and  in  such  a  society,  therefore, 
no  one  could  derive  income  from  capital  without  so 
using  it  as  to  give  a  corresponding  service  to  the 
community  in   return. 

That  all  possible  kinds  of  capital,  and,  therefore, 
all  possible  roundabout  productions,  yield  a  surplus 
over  direct  production  was  not  asserted.  But  there 
seem  to  be  enough  roundabout  applications  of  labor 
which  do  yield,  or  at  least  promise,  a  surplus  over 
direct  production,  to  occupy  more  of  our  effort 
and  attention  than  we  are  willing  to  devote  to  the 
securing  of  deferred  rewards.  Nevertheless,  round- 
about production  appears  to  yield  less  the  farther 


110        Earned  and  Unearned  Incomes. 

it  is  extended.  There  is,  in  this  regard,  a  law  of 
diminishing  returns.  To  increase  indefinitely  the 
amount  of  labor  and  land  devoted  to  capital 
production  will  not  proportionately  increase  the 
gains  from  the  use  of  capital.  There  comes  to  be 
a  relative  superfluity  of  capital.  Nor,  apparently, 
can  the  durability  of  capital  instruments  be  in- 
definitely increased  with  indefinitely  increasing 
advantage. 

To  say  that  roundabout  production  involves  wait- 
ing is  equivalent  to  saying  that  capitalistic  produc- 
tion involves  saving.  In  roundabout  production 
capital  is  an  intermediate  stage  between  eff'ort  and 
its  rewards.  The  production  of  capital  and  like- 
wise its  maintenance  requires  waiting  or  saving, 
requires  a  refraining  from  the  present  consumption 
which  would  otherwise  be  possible.  The  older 
economists  spoke  of  this  refraining  as  abstinence. 
Some  modern  economists  speak  of  it  as  waiting. 
Others  refer  to  time-preference  or  to  impatience. 
Impatience  or  preference  for  present  income  over 
future  income  is  not  universal.  The  man  whose 
present  needs  are  fully  supplied  and  who  an- 
ticipates a  needy  future  may  definitely  prefer 
future  income  to  present.  Even  without  prospect 
of  surplus  gain,  many  persons  may  eagerly  save 
for  old  age  or  to  provide  funds  for  the  support 
and  education  of  their  children  who  may  become 
orphaned.  But  it  is  asserted  that  the  sums  saved 
would  be  less  than  they  are  were  no  surplus 
return  securable  by  saving.  The  argument  to  this 
effect  may  not  seem  to  everyone  absolutely  con- 
vincing. There  may  indeed  be  persons  who  would 
save  more  at  a  lower  interest  than  at  a  higher. 


The  Causes  of  Interest.  Ill 

On  the  whole  it  seems  probable  that  the  lure  of  a 
return  on  accumulated  wealth  is  a  real  influence 
in  increasing  the  amount  of  such  wealth  and  that 
saving  would  be  much  less,  the  amount  of  capital 
less  and,  therefore,  the  amount  of  roundabout 
production  less,  if  saving  and  roundabout  produc- 
tion did  not  pay.  However  this  may  be,  it  seems 
clear  that  roundabout  production  does  yield  a 
surplus,  that  the  amount  of  saving  men  are  will- 
ing to  do  has  not  been  sufficient  to  reduce  the 
marginal  gain  or  surplus  to  zero  and  that  interest 
is  an  important  fact  in  modern  business  life.  The 
way  in  which  capital  productivity  and  the  indis- 
position to  save  indefinitely,  work  together  to 
produce  a  rate  of  interest  will  be  considered  in 
the  next  chapter. 


CHAPTER    IV. 

THE  RATE  OF  INTEREST 

§   1 
The  Choices  of  a  Crusoe 

Before  considering  in  detail  the  working  out  of 
the  forces  determining  interest  in  modern  society, 
let  us  ask  how  these  various  forces  would  act  upon 
an  islanded  Crusoe.  The  Crusoe  of  the  story 
begins  his  isolation,  not  absolutely  without  capital, 
since  something  is  saved  from  the  wrecked  ship, 
but  with  comparatively  little  capital.  As  he  has 
leisure  from  the  activities  necessary  for  present 
support  of  life,  he  devotes  himself  to  making 
equipment  for  his  continued  existence  on  the  island. 
He  builds  himself  a  house,  cuts  a  boat  out  of  a 
log,  makes  himself  bow  and  arrows,  accumulates 
a  herd  of  goats,  and  in  other  ways  prepares  him- 
self against  the  contingencies  of  the  future.  To 
do  this,  he  has,  of  necessity,  either  to  lay  aside  a 
store  of  food  for  use  while  producing  equipment  or 
to  devote  a  part  of  his  time  each  day  or  week, 
while  producing  the  equipment,  to  the  production 
of  necessary  food.  In  either  case  he  may  be  said 
to  use  part  of  his  labor  for  purposes  other  than 
the  satisfaction  of  his  immediate  wants,  to  practice 
abstinence  in  not  immediately  consuming  all  that 
his  labor  produces,  to  save  or  accumulate  the 
results  of  a  part  of  his  labor  against  the  possibil- 
ities of  future  use.  And  in  either  case  this  saving 
takes,  eventually,  the  form  of  buildings,  tools, 
flocks  and  herds,  orchards,  etc. 

(112) 


The  Rate  of  Interest  113 

In  accumulating  these  various  kinds  of  equip- 
ment, Crusoe  uses  a  roundabout  rather  than  a 
direct  method  of  satisfying  his  later  needs.  He 
might  get  along  by  consuming  such  sea  food  as  he 
could  find,  in  various  depressions  and  crannies, 
after  the  outflow  of  the  tides.  He  chooses  rather 
to  deny  himself  some  immediate  satisfactions  in 
order  to  make  a  net  and  fishing  lines.  He  might 
plan  to  use  the  net  and  lines  from  the  shore  or  by 
wading  out  in  the  water.  Instead  he  prefers  to 
sacrifice,  in  part,  the  early  income  thus  securable, 
and  to  devote  some  of  his  time  to  building  a  boat. 
He  might  hunt  all  over  the  island  for  a  goat  to 
kill,  whenever  he  was  hungry  for  meat.  He  chooses, 
however,  to  make  the  sacrifice,  early  in  his 
islanded  life,  either  of  consuming  less  r-ieat  or  of 
spending  more  time  in  goat  capture,  so  that,  later, 
a  minimum  of  labor  may  provide  him  with  a 
maximum  of  meat.  For  a  like  reason  he  builds 
fences  to  keep  his  captured  goats  from  escaping. 

In  all  this  turning  of  labor  to  remote  ends  there 
is  presumably  some  gain.  But  we  may  fairly 
assume  the  most  important,  the  most  advantageous 
capital  to  be  constructed  first.  It  is  important  to 
have  a  net,  less  important  but  still  worth  while 
to  have  a  boat.  Likewise,  progressive  improve- 
ments in  the  quality  of  the  tools  and  buildings 
required,  have  progressively  less  and  less  im- 
portance. Crusoe  must,  therefore,  decide  at  what 
point  he  no  longer  cares  to  make  present  sacrifices 
for  the  larger  but  larger-to-a-decreasing-degree, 
future  gains.  At  the  beginning,  having  little 
accumulated  capital  to  work  with,  Crusoe  has  to 
devote    much    of    his    time    to    supplying    present 


114        Earned  and  Unearned  Incomes 

necessaries.  He  can  devote  little  time  to  producing 
equipment,  just  because  he  has  but  little  equip- 
ment to  work  with.  For  the  same  reason  the 
time  he  is  able  to  devote  to  producing  equipment 
does  not  provide  him  with  any  large  amount  of 
it.  But  roundabout  production  is  of  the  greater 
relative  advantage  to  him  so  far  as  he  can  carry  it 
on,  just  because  he  can  afford  to  resort  to  it  so 
little;  and  this  large  per  cent  gain  may  tempt  him 
to  forego  present  consumption  almost  as  far  as 
he  possibly  can  do  so.  He  practices  abstinence, 
abstaining,  so  far  as  he  can,  from  present  con- 
sumption, for  the  sake  of  the  gains  to  be  realized 
by  so  doing.  When  he  begins  to  realize  these  gains, 
to  enjoy  the  larger  production  which  his  equip- 
ment makes  possible,  or  to  produce  the  old  neces- 
sities in  less  time,  he  will  be  able  to  spare  more  time 
for  the  further  elaboration  of  tools;  but  the  per 
cent  gain  from  so  doing  will  be  reduced.  With 
his  already  accumulated  tools,  Crusoe's  labor 
directed  to  providing  immediate  satisfactions  is 
now  much  more  effective  than  formerly.  More  or 
better  tools  might  result  in  further  gain  but  the 
gain  becomes  progressively  smaller.^ 

But  in  all  this,  though  we  have  influences  of 
the  kind  which  bear  upon  the  rate  of  interest,  we 
do  not  have  a  problem  of  interest  such  as  exists 
in  modern  society.    A  Crusoe  may,  indeed,  compare 

1  Probably  the  rational  thing  for  Crusoe  to  do,  if  he  expected  no 
one  to  follow  hinn,  would  be  to  wear  out  gradually,  as  life  drew  to  a 
close,  the  accumulated  equipment  of  early  years;  but  if  he  could 
hope  to  be  succeeded  by  descendants,  or  others  in  whose  welfare  he 
would  feel  deeply  concerned,  there  would  be  reason  in  his  keep- 
ing up  his  equipment  to  the  last. 


The  Rate  of  Interest  115 

present  goods  and  future.  He  may  determine 
that  his  home  is  the  equivalent  of  a  certain  amount 
of  food.  He  may  give  up  certain  enjoyments  to 
secure  it,  thus  showing  that  he  regards  it  as 
preferable  to  those  enjoyments.  In  a  sense  he  values 
it  in  terms  of  the  kind  of  enjoyments  sacrificed.  But 
there  is  lacking  an  alternative  which  exists  in 
organized  society  as  we  know  it  and  which  has 
considerable  significance,  the  alternative,  that  is,  of 
devoting  himself  to  producing  either  present  or 
future  goods  and  securing  the  other  type  of  goods 
by  exchange.  He  may  produce  the  one  type  of 
goods  or  the  other,  and  he  may  determine  how 
much  of  the  one  type  he  will  have  and  how  much 
of  the  other  and  when  it  no  longer  seems  worth 
while  to  devote  an  extra  hour  to  the  one  purpose  to 
the  exclusion  of  the  other  purpose.  But  he  cannot 
take  advantage  of  his  own  specialized  skill  and 
that  of  another,  to  devote  himself  to  one  line  of 
production  and  trade  the  results  for  the  products 
of  another  line.  There  is  not  open  to  him, 
isolated  as  he  is,  the  opportunity  to  make  capital 
for  the  use  of  others  who  have  not  saved,  when  he 
has  accumulated  so  much  for  his  own  use  as  to 
have  little  to  gain  from  the  production  for  his 
own  use  alone  of  more.  In  other  words,  he  cannot 
devote  himself  entirely  to  production  for  the 
future,  e.  g.  to  making  a  boat,  and  expect  to  trade 
the  results  of  his  labor  for  present  income,  e.  g. 
fish.  Neither  can  he,  if  he  would  have  any  tools 
of  production,  devote  himself  entirely  to  producing 
consumable  goods  and  trade  these  with  anyone 
else  for  production  goods.  Could  he  do  these 
things,  the  rate  at  which  he  would  trade  the  one 


116        Earned  and  Unearned  Incomes 

kind  of  goods  for  the  other  might  well  be  in- 
fluenced by  his  alternative  of  himself  producing 
the  other.  Thus,  the  rate  at  which  he  would  ex- 
change consumable  goods  for  capital  might  well  be 
affected  by  the  alternative  of  his  producing  that 
capital.  There  are,  of  course,  points  of  similarity 
in  the  position  of  a  Crusoe  and  a  man  who  is 
part  of  an  industrial  society,  but  it  seems  never- 
theless necessary,  fully  to  explain  the  phenomena 
of  interest,  to  consider  the  rate  of  interest  in  the 
light  of  the  various  possible  exchanges  and  alter- 
natives which  have  a  bearing  upon  it.  In  particular, 
we  shall  examine  the  bearing,  on  the  rate  of  in- 
terest, of  the  productivity  of  capital  and  of 
impatience  or  the  indisposition  to  save. 

§   2 

The  Demand  for  Present  Goods 

Indirect  or  roundabout  production  differs  from 
direct  production  in  that  it  requires  waiting. 
Therefore  the  surplus  of  relatively  roundabout 
production,  at  the  margin  beyond  which  it  has  not 
been  carried,  over  what  the  same  labor  would  yield 
if  directly  applied,  we  may  term  the  marginal  prod- 
uct of  waiting.  Thus,  if  a  given  amount  of  labor 
can  yield  an  immediate  product  of  100  or  can,  by 
being  stored  in  capital,  yield  a  product  one  year 
later  of  110,  then  the  surplus  product,  10,  may  be 
spoken  of  as  the  marginal  product  of  "waiting." 
If  we  measure  waiting  by  amount  of  gratification 
postponed  and  duration  of  postponement,'  we  may 

2  Suggested  by  C  Cassel,   T/ie  Nature  and  Necessity  of  Interest, 
London   (Macmillan),  1903,  p.  42. 


The  Rate  of  Interest  117 

say  that  the  marginal  product  of  waiting  is,  in 
this  case,  10  per  cent.  In  practice,  roundabout 
production  involves  the  cooperation  of  later  labor 
with  the  capital  which  earlier  labor  has  produced. 
Hence  when  we  suppose  that  labor  turned  to 
roundabout  production  will  produce  (say)  10 
per  cent  more  than  the  same  amount  of  labor 
turned  to  direct  production,  we  do  not  mean  that 
this  year's  labor,  for  example,  will  produce 
capital  which,  a  year  later,  and  without  any  co- 
operation of  further  labor  with  it,  will  yield  a 
product  10  per  cent  larger  than  could  have  been 
produced  directly.  We  mean,  rather,  that  if  the 
"center  of  gravity"  in  time,  of  the  receiving  of  the 
product  of  the  labor,  is  a  year  later  than  the 
time  center  of  gravity  of  the  putting  forth  of 
effort,  the  product  will  be  10  per  cent  larger  than 
if  it  is  received  currently  with  the  application  of 
the  labor.  To  illustrate,  suppose  that  labor  is 
put  forth  daily  for  three  years  but  that  for  the 
first  two  years  no  consumable  return  is  derived, 
the  return  being  realized  throughout  the  third 
year,  during  which  the  capital  produced  is  operated 
and  wears  out.  The  time  center  of  gravity  of  the 
labor  would  then  be  a  year  and  a  half  from  the 
beginning  of  the  process  and  the  time  center  of 
gravity  of  receiving  the  consumable  return  would 
be  two  years  and  a  half  from  the  beginning.  The 
return  may  therefore  be  said  to  be  received  a 
year  later  than  the  labor  is  put  forth. ^     And  if 

3  See    Bohm-Bawerk's    explanation    of    an     "average   production 
period,"       The    Positive    Theory    of    Capital,    English    Translation, 


118        Earned  and  Unearned  Incomes 

this  return  is  10  per  cent  larger  than  could  have 
been  secured  by  carrying  on  direct  production  and 
getting  consumable  goods  currently  throughout 
the  three  years,  then  the  marginal  product  of  wait- 
ing may  be  said  to  be  10  per  cent.  In  the  abstract 
discussion  which  is  presented  in  this  and  the 
next  few  sections  of  this  chapter,  the  expressions 
"this  year's  labor"  and  "present  labor"  may  be 
understood  to  have  reference  to  labor  of  which  the 
time  center  of  gravity  is  in  the  present,  and  ex- 
pressions relating  to  "present  goods"  or  "next 
year's  goods"  may  be  also  interpreted  in  terms  of 
a  time  center  of  gravity. 

We  have  seen  that  roundabout  production  yields 
a  surplus  over  direct  production.  By  so  doing  it 
affects  simultaneously  the  rate  of  interest  and 
individual  rates  of  impatience  (rates  of  preference 
for  present  goods  over  future  goods).  We  shall 
see,  as  we  proceed,  that  it  does  not  affect  the 
former  primarily  by  first  determining  the  latter. 
To  show  how  greatly  the  productivity  of  waiting 
can  influence  interest,  let  us  assume  that  indirect 
production  could  be  indefinitely  extended  without 
reducing  the  reward  of  marginal  waiting  below 
10  per  cent.  Then  the  rate  of  interest  could  not 
be  less  than  10  per  cent,  nor  could  individual  rates 
of  impatience  be  less,  and  the  marginal  productiv- 
ity of  waiting  might  be  said,  in  so  far,  to  deter- 
mine both.  It  determines  interest  by  affecting 
both  the  demand  and  the  supply  sides  of  the 
market.     It  determines  impatience  by  causing  the 

London   (Macmillan) ,  1891,  p.  89.  Cf.  Jevons,  The  Theory  of  Politi- 
cal Economy,  fourth  edition,  London  (Macmillan),  191 1,  pp.  227-229. 


The  Rate  of  Interest  119 

adoption,  to  a  considerable  degree,  of  roundabout 
production,  and  therefore  making  present  income 
relatively  scarce  and  future  income  relatively 
abundant.     Thus  impatience  is  increased.* 

Putting  the  matter  in  terms  of  demand  for  and 
supply  of  present  goods,  we  may  say  that  if  the 
indirect  method  would  yield  continuously,  and 
even  though  indefinitely  extended,  a  10  per  cent  sur- 
plus, then  a  rate  of  exchange  of  less  than  110  of 
next  year's  goods  for  100  of  this  year's  would 
mean  a  demand  for  present  goods  in  excess  of 
the  supply.  On  the  demand  side,  if  the  marginal 
product  of  waiting  is  equal  to  10,  the  possibility  of 
getting  100  of  present  goods  for  105  of  next  year's 
goods,  would  mean  a  greater  demand  for  the  pres- 
ent goods  than  if  the  marginal  product  of  waiting 
were  but  5.  For  all  those  classes  of  persons,  e.  g., 
spendthrifts  and  necessitous  persons  such  as  labor- 
ers, who,  in  effect,  habitually  buy  present  goods 
with  future,  would  have,  with  the  higher  assumed 
productivity  of  the  roundabout  methods  at  which 
they  are  engaged  or  to  which  they  can  turn,  more 
future  goods  to  offer  for  present.  At  a  rate  of 
exchange  of  105  future  for  100  present,  they  would, 
in  producing  110  future  and  buying  100  present, 
have  5  of  future,  i.  e.,  next  year's  goods,  left  over 
with  which  to  demand  more  present  goods;  where- 
as if  roundabout  production  were  only  5  per  cent 
superior,  this  surplus  demand  for  present  goods 
could  not  exist.  Thus,  with  a  marginal  pro- 
ductivity of  waiting  equal  always  to  10  per  cent, 

*  See  Bohm-Bawerk,  Positive  Theorie  des  Kapitales,  Dritte 
Aufiage,  (Innsbruck),  1912,  p.  468.  Ci.  Fisher,  The  Rate  of  In- 
terest, New  York    (Macmillan) ,  1907,  pp.  186,  187. 


120        Earned  and  Unearned  Incomes 

necessitous  wage  earners,  if  they  received  100  of 
present  goods  for  every  105  of  next  year's  goods 
produced  by  their  w^ork,  might  be  said  to  demand 
more  present  goods  than  if  the  marginal  productiv- 
ity of  waiting  were  only  5  per  cent.  For  in  the 
former  case  they  still  have  a  future  product  of 
5,  after  getting  100  in  present  goods,  for  which 
surplus  5  they  demand  a  further  quantity  of  this 
year's  goods.  We  may  therefore  assert  that  the 
higher  is  the  marginal  product  of  waiting  and  the 
more  slowly  this  marginal  product  declines  with 
increased  quantity  of  waiting,  the  greater  will  be 
the  demand,  at  any  given  price  or  value  in  future 
goods,  for  present  goods.  This  is  a  use  of  the  term 
"demand"  analogous  to  its  use  in  the  theory  of 
price  and  value.  Unfortunately,  economists  are 
apt,  in  such  discussions  as  the  present,  to  use  the 
terms  "supply"  and  "demand"  loosely  and  without 
careful  analysis. 

It  should  be  observed  that  this  greater  demand 
for  present  goods,  at  a  rate  of  105  of  next  year's 
goods  for  100  now,  due  to  the  10  per  cent  supe- 
riority of  indirect  production,  is  not,  necessarily, 
brought  about  through  any  effect  on  impatience. 
The  greater  demand  for  present  goods  at  any  rate 
of  interest  less  than  10  per  cent  may  be  due  direct- 
ly to  this  superior  productiveness  of  the  capitalistic 
method,  or,  if  we  use  Bohm-Bawerk's  phrase,  to 
the  technical  superiority  of  present  goods.  Let  us 
suppose,  for  illustration,  a  man  who  must  have  100 
this  year  in  order  to  maintain  life.  He  does  not 
possess  it  and  if  he  cannot  borrow  it,  will  have  to 
produce  it.  But  if  he  can  borrow  it  he  will  then 
be    in    a    position    to   turn    his    attention    towards 


The  Rate  of  Interest  121 

roundabout  production,  which,  otherwise,  he  could 
not  possibly  do;  and  he  will  therefore  be  able  to 
produce  110  a  year  later  with  the  same  labor  re- 
quired to  produce  100  this  year.  Will  he  not,  if 
interest  is  5  per  cent  (or  anything  less  than  10)  be 
very  glad  to  get  100  of  present  goods  and  so  be 
able  to  produce  110  a  year  later?  Yet  this  will  not 
of  necessity  be  due  to  his  impatience.  He  may  be 
a  man  who,  were  any  other  way  possible  of  getting 
the  110  next  year,  would  refuse  to  borrow  100  even 
at  only  one  per  cent  interest.  He  may  have  so 
little  impatience  that  even  an  income  stream  rising 
at  such  a  rate  as  10  per  cent,  would  not  induce 
him  to  seek  present  goods  for  future.  He  may 
have  a  zero  rate  of  impatience,  if  not  a  negative 
one.  If  he  borrows  100  for  this  year's  use,  in 
order  that  he  may  work  hard  at  roundabout  pro- 
duction when  otherwise  he  would  do  an  equal 
amount  of  work  in  securing  100  in  this  year's 
goods,  it  certainly  cannot  be  said  that  he  borrows 
in  order  to  provide  for  present  needs  out  of  future 
abundance,  for  his  present  needs  are  7io  better  pro- 
vided for  than  if  he  did  not  borrow.  He  works 
just  as  hard  and  has  this  year  no  greater  income. 
The  fact  is  that  such  a  man  does  not  horroiv  be- 
canse  he  is  impatient  and  ivants  more  present  in- 
come at  the  expense  of  his  future.  In  borrowing, 
he  really  is  not  comparing  this  year's  100  with 
next  year's  repayment  of  105,  for  he  could  get  this 
year's  100  for  the  work  he  is  in  any  case  doing. 
He  is  comparing  the  110  which  roundabout  pro- 
duction will  yield  him  next  year,  with  the  105  of 
next  year's  goods  (or  anything  less  than  110) 
which  he  must  pay  for  the  110.     He  is  comparing 


122        Earned  and  Unearned  Incomes 

tivo  futures,  rather  than  a  present  and  a  future.^ 
He  is  going  to  have  100  this  year  whether  he  bor- 
rows or  not.  He  is  going  to  do  a  given  amount  of 
productive  work  this  year  whether  he  borrows  or 
not.  If  he  borrows  he  simply  makes  the  difference 
between  110  and  what  he  has  to  pay  next  year  for 
the  loan.  In  what  possible  sense  can  it  be  said 
that  he  borrows  only  because  he  is  impatient? 

Here  we  may  note  an  error  in  Fisher's  criticism 
of  Bohm-Bawerk,  though  one  which  appears  to  lurk 
in  the  latter's  own  presentation  of  his  theory.  Pro- 
fessor Bohm-Bawerk  in  his  Positive  Theory  of  Capi- 
tal^ has  a  series  of  tables  illustrating  the  technical 
superiority  of  present  goods,  the  point  being  that 
early  goods  are  to  be  preferred  to  later  because 
they  make  possible  more  roundabout  production, 
e.  g.,  to  use  the  figures  of  this  article,  that  100 
this  year  is  preferable  to  100  next  year,  because  100 
this  year  makes  possible  110  next  year,  through  the 
adoption  of  roundabout  processes.  Fisher's  argu- 
ment is,  in  effect,'  that  100  now  would  be  no  better 
than  100  next  year,  if  man  were  not  impatient, 
because  100  next  year  would  make  possible  110  year 
after  next;  that  as  much  would  be  enjoyed  even- 
tually, and  so  if  one  did  not  mind  waiting,  either 
option  would  be  as  good  as  the  other.  Professor 
Fisher's  statement^  is  that  "the  only  reason  any- 

■''  Cf.  Bohm-Bawerk,  Positi've  Theorie  des  Kapitales,  Dritte 
Auflage     1912,  (Exkurse),  pp.  406-409. 

<*  The  Positive  Theory  of  Capital,  English  Translation,  London 
(Macmillan),  1891,      pp.    262-269;    Dritte   Auflage,  456,466. 

^  The  Rate  of  Interest,  pp.  58-71. 

*  Ibid.,  pp.  70,  71. 


The  Rate  of  Interest  123 

one  can  prefer  the  product  of  a  month's  labor  in- 
vested today  to  the  product  of  a  month's  labor  in- 
v^ested  next  year  is  that  today's  investment  will 
mature  earlier  than  next  year's  investment."  In 
view  of  what  has  been  said  in  the  foregoing  pages, 
it  seems  to  the  present  writer  that  this  criticism 
really  fails  to  meet  the  essential  point  of  the  argu- 
ment. So  long  as  100  this  year  makes  possible  110 
next  year,  many  persons  will  be  very  anxious  to  get 
the  100  provided  they  do  not  have  to  pay  back 
quite  all  of  the  110.  Their  total  income  will  be 
larger  and  not  m.erely  earlier  because  of  such  a 
choice.  A  proper  comparison  of  the  two  options 
begins  iDith  the  present  in  both  cases,  not,  as  Pro- 
fessor Fisher  would  have  us  believe,  a  year  later 
in  one  case  than  in  the  other.  In  either  case,  in- 
come and  work  would  begin  with  this  year.  In  the 
one  case  the  loan  of  100  would  make  possible  begin- 
ning the  more  productive  indirect  method  at  once. 
In  the  other  case  the  first  year  would  have  to  be 
spent  in  the  use  of  the  less  productive  direct 
method.  All  question  of  impatience  aside,  the  first 
choice  would  be  preferable  to  the  second  since  it 
would  yield  during  any  given  period,  a  greater  total 
result.^  Nevertheless  it  must  be  admitted  that 
Bohm-Bawerk's  tables  do  not  all  consistently  ex- 
press  this   view.'" 

^  See  Bohm-Bawerk,  T/ie  Positive  Theory  of  Capital,  English 
Translation,  p.  271;  Dritte  Auflage,  p-  469.  See  also  Exkiirse  XII, 
in  answer  to  Fisher's  criticisms. 

^^  Thus,  in  the  tables  beginning  on  page  266  (English  transla- 
tion), Bohm-Bawerk  selects  for  comparison  the  maximum  value  in- 
comes derivable  from  earlier  and  later  labor  even  though  this 
means  comparison  of  an  income  received  in  1890  from  labor  availa- 


124        Earned  and  Unearned  Incomes. 

Professor  Fisher,  in  attempting  to  show  that 
all  loans  are  really  made  to  provide  present  income 
for  those  who  desire  the  loans,  even  if  they  are  so- 
called  productive  loans,  assumes  the  case  of  a 
business  man  who  borrows  to  make  an  investment 
and  who  has  the  three  options  of  not  investing, 
and  of  making  the  investment  by  sacrificing  part 
of  his  early  income  for  the  sake  of  later  or  by  bor- 
rowing so  as  not  to  have  to  sacrifice  early  income. ^^ 
But  in  our  example  above  described,  the  borrower 
has  but  the  first  and  third  of  these  options.  If  he 
cannot  borrow,  he  cannot  invest,  that  is,  he  cannot 
choose  roundabout  production.  It  cannot  be  said, 
therefore,  that  he  borrows  to  supply  present  needs, 
and  it  cannot  be  said  that  borrowing,  in  general, 
is  necessarily  a  means  of  providing  the  present  at 
the  expense  of  the  future,  but  that  there  really  are, 
contrary  to  the  viewpoint  of  Fisher,^^  productive 
loans  in  the  sense  in  which  economists  have  used 
that  expression.  Impatience  is  only  one  cause, 
and  perhaps  a  minor  cause,  of  the  demand  for 
present   goods. 

In  concluding,  now,  our  analysis  of  the  demand 
side  of  the  market  in  so  far  as  it  shows  a  tendency 
of  productivity  of  waiting  to  keep  interest  up,  may 
we  not  state  a  quantitative  result?  Assuming  that 
the  marginal  productivity  of  waiting,  however  far 
extended,  is  10  per  cent,  and  that  the  supply  of 

ble  in   1888  with   an  income  received  in   189J  from  labor  available 
in  1889. 

^1  The  Rate  of  Interest,  pp-  246-251. 

^2  Ibid.,    p.    251. 


The  Rate  of  Interest.  125 

present  or  early  goods  is  not  unlimited,  may  we  not 
assert  that  at  a  rate  of  intereat  appreciably  less 
than  10  per  cent,  the  demand  for  present  goods  or 
relativelij  early  goods,  must  exceed  the  supply? 
For  even  those  who  are  not  by  nature  so  impatient 
as  to  purchase  present  goods  for  future  at  that 
rate  will  nevertheless  purchase  present  or  compar- 
atively early  goods,  that  they  may  extend  the 
amount  or  the  time  of  indirect  production  and 
reap  a  gain  in  so  doing." 


The  Supply  of  Present  Goods  Offered  for  Future 

Goods 

On  the  other  hand,  a  high  marginal  productivity 
of  capital  or  of  waiting  tends  to  decrease  the  supply 
of  present  goods,  at  any  given  price  in  terms  of 
future  goods.  Thus,  with  the  marginal  productivity 
of  indirect  production  110,  however  far  extended, 
as   against   100    for   direct,    nobody   would    supply 

^^  The  contention  is  sometimes  made  by  productivity  theorists 
that  increased  productiveness  of  capital  must  be  assumed  to  raise  the 
rate  of  interest  because  value  is  relative  and  all  values  cannot  go 
down  (Seager,  The  Impatience  Theory  of  Interest,  American 
Economic  Review,  December,  1912,  pp.  834  and  835).  Even  though 
the  supposition  be  made,  for  greater  clearness  of  exposition,  that  the 
quantity  of  money  and  credit  keeps  such  a  relation  to  goods  as  lo 
maintain  an  unchanging  general  price  level,  such  an  argument  is 
hardly  sufficient.  For  the  impatience  theorist  might  still  argue  that 
the  value  of  capital  would  go  up  and  the  value  of  consumable  goods 
down  because  of  the  increased  capital  productiveness,  and  that  in- 
terest would  not  rise.  Some  such  argument  as  is  presented  in  this 
chapter  is  believed,  therefore,  to  be  essential  if  the  problem  is  to 
be   anything   like  completely   analyzed. 


126        Earned  and  Unearned  Incomes. 

present  goods  at  all  if  offered  a  price  of  only  105  in 
next  year's  goods  for  100  present.  If  roundabout 
production  yielded  less,  say  4  or  5  per  cent,  such  an 
offer  might  bring  out  a  supply  of  present  goods. 
But  with  roundabout  production  yielding  a  10  per 
cent  yearly  surplus,  it  would  not  be  worth  while 
for  any  one  to  produce  present  goods  at  all  in  order 
to  make  such  an  exchange.  Rather  than  produce 
present  goods  to  the  amount  of  100  and  exchange 
or  sell  them  for  105  of  next  year's  goods,  any 
producer  would  prefer  to  get,  by  the  indirect 
method,  110  of  next  year's  goods.  We  may  put 
the  matter  in  a  somewhat  different  way  if  we  first 
call  attention  to  the  fact  that  wages  are  paid,  in 
the  first  instance,  neither  in  present  consumption 
goods  nor  yet  in  future  goods  (durable  capital) 
but  in  general  purchasing  power.  The  amount  that 
an  employer  has  to  pay  in  wages  will,  presumably, 
be  the  same  whether  he  employs  his  men  in  direct 
or  indirect  production,  in  producing  present  or 
future  goods.  But  if  employing  them  in  indirect 
production  will  yield  110,  no  employer  is  going  to 
pay  the  same  wages  for  present  goods  of  100,  and 
then  supply  these  goods  for  the  equivalent  of  105 
in  the  goods  of  a  year  later.  An  employer  will 
either  receive  for  his  100  a  purchasing  power  over 
110  of  next  year's  goods,  or  he  will  have  next 
year's  goods  produced  instead  of  present  goods.  It 
appears,  therefore,  that  if  indirect  production  can 
be  indefinitely  extended  with  a  surplus  return  of 
10  per  cent,  any  appreciably  less  rate  of  interest 
than  10  per  cent  would  certainly  mean  a  supply 
of  present  goods  less  than  the  demand.     Therefore 


The  Rate  of  Interest.  127 

a  rate  of  appreciably  less  than  10  per  cent  could 
not  continue. 

It  is  worth  while  calling  attention  again  at  this 
point  to  the  fact  that  we  are  dealing  here  with  an 
independent  cause  of  interest  other  than  impatience. 
It  is  not,  in  our  example,  because  those  on  the 
supply  side  of  the  market  are  impatient,  that  they 
will  not  dispose  of  100  present  goods  for  less 
than  110  of  next  year's  goods.  It  is  rather  because 
nature  or  invention  or,  more  properly,  both,  gives 
them  the  option  of  getting  the  110  next  year, 
through  their  ov/n  present  efforts,  if  they  will, 
instead  of  by  lending  or  selling  present  goods  for 
future.  Is  a  man  impatient  because  he  will  not 
accept  105  of  next  year's  goods  when  he  may,  by 
the  same  present  effort,  get  110?  The  choice  is 
between  a  smaller  future  income  and  a  larger,  not 
between  a  present  and  a  future  income.  How, 
therefore,  can  impatience  be  said  to  be  involved  as 
the  cause?  Impatience  or  time  preference  is  a 
state  of  mind  relating  to  present  compared  with 
future  goods;  not  related  to  future  compared 
with  other  future  goods. 

The  above  argument  shows,  it  is  believed,  that 
productivity  of  capital  has  both  a  direct  and  a 
proportionate  effect  upon  the  rate  of  interest,  if  by 
productivity  we  here  mean  surplus  productivity 
over  direct  production.  To  double  the  surplus 
productivity  of  any  one  instrument  of  capital  would 
not,  of  course,  appreciably  affect  the  rate  of 
interest,  because  it  would  mean  but  a  slight 
change  in  the  market  conditions  of  supply  and 
demand.  The  increased  supply  of  products  or 
uses  would,  if  the  capital  were  itself  produced  by 


128        Earned  and  Unearned  Incomes. 

labor,  merely  lower  their  price  in  relation  to  other 
goods.  But  permanently  to  double  the  surplus 
productivity  of  capital  in  general,  in  other  words 
to  double  the  marginal  product  of  waiting  and 
to  keep  this  marginal  product,  however  great  the 
increase  of  waiting,  double  what  it  has  been,  would, 
and  must,  not  less  than  double  the  rate  of  interest. 
For  if  the  surplus  marginal  productivity  of  capital 
were  changed  from  10  to  20  per  cent,  no  one 
would  any  longer,  however  low  his  impatience, 
consent  to  lend  or  invest  present  goods  for  10  per 
cent.  Rather  would  he  adopt  indirect  production 
and  realize  20.  His  refusal  to  accept  10  would  not 
be  due,  necessarily,  to  his  impatience  but  directly 
to  the  fact  that  he  has  now  a  better  option  than 
before.  The  assertion  that^*  "to  raise  the  rate  of 
interest  by  raising  the  productivity  of  capital  is, 
therefore,  like  trying  to  raise  one's  self  by  one's 
own  boot-straps,"  hardly  gives  a  true  account  of 
the  situation  even  though  only  a  direct  and  not  an 
indirect  effect  is  denied.  Neither  is  it  convincing 
to  state  that^^  "an  increase  of  the  productivity  of 
capital  would  probably  result  in  a  decrease  instead 
of  an  increase,  of  the  rate  of  interest,"  and  that  "to 
double  the  productivity  of  capital  might  more  than 
double  the  value  of  the  capital,"  unless  by 
productivity  is  meant  productivity  in  general  and 
not    merely    the    surplus    productivity    of    indirect 

^*  Fisher,  The  Rate  of  Interest,  p.  15- 

1''  Fisher,  The  Rate  of  Interest,  p.  16.  But  it  is  only  fair  to  state 
that  Professor  Fisher's  elaborated  theory  gives  considerable  empha- 
sis to  productivity  as  an  indirect  cause  working  through  impatience. 


The  Rate  of  Interest.  129 

production.  As  a  matter  of  fact  to  double  the 
surplus^'^  marginal  product  from  10  to  20  and  keep 
it  so,  would  very  decidedly  not  double  the  value  of 
capital.  For  no  one,  however  low  his  impatience, 
would  be  willing  to  give  more  than  100  in  present 
goods  for  120  of  next  year's  goods  when  the  labor 
necessary  to  produce  the  present  100  would  be 
sufficient  to  produce  the  deferred  120.  It  is  true 
that  such  an  increase  of  productivity  as  we  have 
assumed  might,  when  it  had  greatly  increased 
wealth,  tend  to  reduce  impatience  and  therefore, 
eventually,  to  make  possible  an  extension  of  in- 
direct production  to  where  the  marginal  product  of 
waiting  was  a  smaller  amount  than  before.  But 
unless  and  until  it  did  this,  the  greater  productivity 
could  not  possibly  result  in  a  decrease  of  the  rate 
of  interest.  And  it  is  certainly  not  true  as 
Professor  Fetter  would  have  us  believe,  that  a 
theory  which  asserts  productivity  to  be  an  in- 
dependent, direct  cause  and  determinant  of  interest 
must  assume  a  rate  of  interest  in  its  premises  and 
so  involves  a  begging  of  the  question.^'  It  starts 
with  a  rate  of  interest  only  in  the  sense  that  it 
starts  with  a  rate  of  productivity  which  in  large 
part  determines  the  rate  of  interest.  Even  the 
productivity  theorist  who  asserts,  flatly,  that 
interest  will   be   20  per  cent  if  a   capital   of   100 

1^  If  the  surplus  marginal  product  !s  lo,  the  total  marginal 
product  of  capital  is  no.  To  double  this  would  make  it  220,  in- 
creasing the  surplus  marginal  product,  or  the  marginal  product  of 
waiting,  to  120. 

1'^  See,  for  example,  Professor  Fetter's  critical  article.  Interest 
Theories,  Old  and  Nnv,  in  the  American  Economic  Review,  March, 
1914,  especially  page  90. 


130        Earned  and  Unearned  Incomes 

produces  on  the  average,  at  the  end  of  a  year,  an 
income  of  120,  though  his  analysis  may  be  incom- 
plete, is  not,  perhaps,  fundamentally  in  error.  For 
it  is  not  necessarily  true  that  a  person  values  his 
capital  at  100  only  because,  having  an  impatience  of 
20  per  cent,  he  discounts  the  expected  income  at  a 
20  per  cent  rate.  On  the  contrary,  he  values  his 
capital  at  100  because  the  amount  of  labor  neces- 
sary to  produce  it,  i.  e.,  necessary  to  get  a  final 
result  a  year  later,  of  120,  is  just  equal  to  the 
amount  of  labor  necessary  to  get  100  right  away. 
He  does  not  value  the  capital  at  more  than  that,  i.  e., 
will  not  give  more  than  that  for  it,  because  he 
has  the  option  of  always  being  able  to  get  it  at 
that  price  or  value  in  terms  of  labor.  The  sum 
100  may  properly  be  called  its  cost  of  production. 
In  this  sense  it  is  fair  to  say  that  interest  is  20 
per  cent  if  and  because  a  capital  of  100  will  produce 
income  at  the  end  of  a  year,  of  120,  or  will  produce 
20  a  year.  We  may  say  that  a  person's  valuation  of 
capital,  along  with  the  valuations  of  other  persons 
in  like  situation,  is  less  the  direct  result  of  a 
previously  existing  market  rate  of  interest,  than  it 
is,  by  affecting  his  and  their  attitude  towards  the 
market,  a  determinant  of  the  rate  of  interest. 

We  are  prepared,  now,  to  see  more  clearly  than 
before  the  importance  of  the  distinction  between 
land  and  made  capital.  Land  is  already  present. 
For  the  most  part  there  is  no  balancing  of  choice 
as  to  whether  or  not  we  shall  produce  it.  Its  value 
depends  upon  its  expected  future  benefits  and  the 
rate  of  interest  or  impatience  at  which  they  are 
discounted.  But  there  is  the  option,  during  any 
period,  of  producing  more  or  less  of  other  capital. 


The  Rate  of  Interest  131 

turning  towards  or  away  from  roundabout  pro- 
duction. The  value  of  this  other  capital  is  just 
as  much  dependent  upon  its  cost  of  production,  in 
the  sense  above  explained,  as  upon  any  indepen- 
dently existing  rate  or  rates  of  impatience.  The 
possibility  of  getting  a  larger  product  of  labor,  a 
surplus  over  the  reward  of  direct  production,  by 
applying  that  labor  indirectly,  with,  as  an  interme- 
diate step,  the  use  of  "produced  means  to  further 
production, "^^  will  tend  to  prevent  enterprisers  and 
others  from  accepting  any  less  surplus  as  interest  on 
loans  or  on  purchase  of  goods  already  produced. 
This  possibility  wall  therefore,  in  so  far,  tend  to  fix 
the  rate  of  interest  and  of  discount. 

Does  impatience  then  enter  nowhere  into  the 
chain  of  cause  and  affect?  It  does  enter,  but,  in 
the  connection  to  be  now  emphasized,  as  effect 
rather  than  cause.  The  marginal  productivity  of 
waiting,  if  10  per  cent  regardless  of  extension,  will 
directly  influence  supply  of  and  demand  for  present 
goods  in  such  a  way  that,  at  any  lower  interest 
rate  than  10  per  cent,  supply  will  fall  short  of 
demand.  It  is  also  true  that  a  marginal  produc- 
tivity of  waiting,  of  10  per  cent,  will  cause  rates 
of  impatience  to  be  correspondingly  high.  The 
supply  of  and  demand  for  present  goods,  and  hence 
the  rate  of  interest,  is  one  chain  of  effects  follow- 
ing from  the  marginal  productivity  of  waiting. 
The  comparative  deprivation  of  the  present  and 
endowment  of  the  future  and  the  consequent  high 
rate    of    impatience,    constitute    another    chain    of 

1^  Phrase  used  by  Seager,  The  Impatience  Theory  of  Interest, 
American   Economic   Review,    December,    1912,   p.   846. 


132        Earned  and  Unearned  Incomes 

effects.  We  are  here  dealing  with  common  effects 
of  a  joint  cause,  not  with  a  single  chain  of 
causation. 

§   4 

Demand  for  and  Siipijly  of  Present  Goods  Further 

Considered 

On  the  other  hand,  still  assuming  a  marginal 
product  of  waiting  equal  to  10  per  cent,  and  assum- 
ing now  that  it  does  not  become  greater  than  that 
even  with  indefinite  decrease  of  roundabout  pro- 
duction; then  at  a  higher  rate  of  interest  than  10 
per  cent,  we  should  expect  to  find  demand  for 
present  goods  less  than  supply.  If  the  rate  of 
interest  were  15  per  cent,  that  is  if  the  price  of 
present  goods  in  terms  of  future  were  115,  compara- 
tively few  persons  would  be  willing  to  buy  present 
goods.  Why  offer  115  of  next  year's  goods  for  100 
of  this  year's  when  100  of  this  year's  can  be  pro- 
duced by  the  direct  method  in  the  same  time  that 
it  takes  to  produce  only  110  of  next  year's.  There 
might  be  persons  of  spendthrift  habits  and  no 
trustworthiness  who  would  be  willing  to  promise 
almost  any  price  in  future  goods  in  order  to  get 
100  in  present  goods.  But  such  persons  could 
not  be  relied  on  to  pay  the  price  and,  therefore,  are 
not  really  in  the  market.  They  have  a  desire 
rather  than  a  demand.  There  might  be  a  real 
demand  for  present  goods  at  a  15  per  cent  rate 
from  persons  of  spendthrift  proclivities  who,  by 
past  accumulations  or  by  inheritance  of  capital, 
possessed  the  means  to  pay.  But  such  persons 
would  soon  eliminate  themselves  as  factors  in  the 


The  Rate  of  Interest.  133 

problem,  and  even  while  they  were  in  the  market, 
conditions  of  supply  would  keep  interest  down  to 
about  10  per  cent.     The  great  mass  of  consumers 
would  not  be  in  a  position  to  give,  as  a  rule,  more 
than  10  per  cent.     Most  of  them  are  wage  earners 
and    in    many    cases   they   have    little    security    to 
offer.     They  buy  present  goods,  in  effect,  with  the 
future  goods  their  labor  produces.     That  is  their 
chief  and  in  many  cases  their  only  means  of  pur- 
chase.    If  the  same  labor    which  produces  110  of 
next  year's  goods  by  the  indirect   method,   would 
produce   directly    100    of   this   year's,    they    would 
not  bid  for  the  100,  an  amount  equal  to  115  of  the 
goods  available  a  year  later.     Rather  than  do  this, 
they  would  seek  employment  producing  directly  this 
year's  goods  and  so  avoid  the  15  per  cent  interest. 
Looking  at  the  matter  from  the  supply  side,  we 
may  say  that  a  rate  of  interest  of  15  per  cent  when 
the  marginal  product  of  waiting  is   10  per   cent, 
would    almost    certainly    result    in    a    supply    of 
present  goods  in  excess  of  the  demand.    For  no  one 
would  produce  110  of  next  year's  goods,  however 
little  impatient  he  might  be,  so  long  as  he  could 
produce  with  the  same  labor,  100  of  present  goods 
and    sell   them   for    115   of   next   year's.      No    one 
would   hire   labor   to   produce   110   of   next   year's 
goods   when    for    the    same    wages    he    could    hire 
them  to  produce  100  of  this  year's  and  could  sell 
this  100  for  115  of  next  year's.   In  short,  at  a  rate 
of  interest  of  15  per  cent,  the  supply  of  present 
goods  would  exceed  the  demand,  by  the  turning  of 
quantities  of  labor  from  indirect  to  direct  produc- 
tion, until  the  large  amount  of  early  income  and  the 
scarcity   of   future   income,    lowered    interest   and 


134        Earned  and  Unearned  Incomes. 

impatience  to  10  per  cent.  The  influence  of  supply 
would  keep  interest  as  low  as  10  per  cf-nt  for  all 
those  able  to  give  security  and  therefore  really 
in  the  market,  unless  mankind  were  so  little  thrifty 
that  no  amount  of  turning  production  to  the  direct 
method,  no  possible  stocking  of  the  present  and 
deprivation  of  the  future,  could  keep  their  impa- 
tience down  to  10  per  cent,  the  assumed  produc- 
tivity of  waiting.  In  such  a  world  or  such  a 
community,  there  soon  would  be  no  indirect  or 
capitalistic  production,  but  a  mere  living  from 
hand  to  mouth;  and  there  could  be  no  loans  except 
the  so-called  unproductive  loans. 

We  may  conclude,  therefore,  that  by  acting  on 
the  supply  of  present  goods  and  the  demand  for 
them,  the  superiority  of  roundabout  production 
tends  to  keep  interest  down  to  as  well  as  up  to 
the  marginal  productivity  of  waiting.  Interest 
to  those  really  in  the  market  (because  able  to  give 
security),  cannot  go  above  this  per  cent  so  long 
as  a  community  is  thrifty  enough  to  use  any  degree 
of  indirect  production,  and  is  therefore  able  to 
increase  present  goods  and  decrease  future  by  turn- 
ing more  largely  toward  direct  production.  And 
it  cannot  go  below  this,  so  long  as  a  community 
has  still  not  reached  an  impassible  limit  of  in- 
direct production  but  is  yet  able  to  turn  more  labor 
toward  indirect  production  or  to  make  the  method 
of  production  still  more  roundabout, — to  increase 
either  the  amount  or  the  time,  of  waiting. 

Assuming,  therefore,  a  constant  marginal  produc- 
tivity of  waiting,  equal  to  10  per  cent,  and  a  rate 
of  impatience  affected  by  the  shape  of  the  income 
stream,   this   rate   of   impatience,   as   well   as   the 


The  Rate  of  Interest.  135 

rate  of  interest,  will  adjust  itself  to  the  rate  of 
productivity  of  waiting.  On  the  other  hand,  were 
we  to  assume  a  constant  natural  rate  of  impatience 
regardless  of  changes  in  the  income  stream,  and  at 
the  same  time  a  productivity  of  waiting  decreas- 
ing with  the  extension  of  indirect  production,  tlien 
the  marginal  productivity  and  the  rate  of  interest 
would  adjust  themselves  to  the  impatience.  In 
practice,  doubtless  adjustment  takes  place  both  in 
marginal  productivity  of  waiting  and  in  impatience, 
but  the  influence  of  productivity  has,  it  is  believed, 
an  importance  which  we  are  not  likely  to  over- 
emphasize. 

In  a  modern  community  production  is  capitalistic 
to  a  great  degree.  It  would  be  possible  to  make  it 
capitalistic  to  an  indefinitely  greater  degree  with 
continuing  gain  in  productiveness.  We  are  little 
interested  in  the  theory  of  how  interest  might  be 
fixed  in  a  community  where  the  general  rate  of 
impatience  is  too  high  to  permit  any  accumulation 
at  all,  or  in  a  world  where  further  extension  of 
indirect  production  is  impossible.  In  our  existing 
civilization,  the  fact  that  capitalistic  production 
could  be  much  further  extended,  with,  for  a  long 
time  at  least,  a  surplus  gain,  is  of  tremendous 
importance.  It  means  that  no  amount  of  accumula- 
tion can  be  expected  to  reduce  the  rate  of  interest 
to  zero.^''  It  means  that  the  marginal  product  of 
waiting  is  one  of  the  most  important  factors  in 
fixing  the  rate  of  interest,  worthy  of  the  emphasis 
which    the    marginal    productivity    theorists    have 

1^*038561,  T/ie  Nature  nnd  Necessity  of  Interest,  London  (Mac- 
millanl,  1903,  pp.  156,  157. 


136        Earned  and  Unearned  Incomes 

given  to  it,  and  that  any  theory  which  does  not 
give  large  emphasis  to  this  determining  influence 
acting  simultaneously  on  impatience  and  interest  is 
either  inadequate  or  misleading  or  both.  It  means 
that  if  the  productivity  of  waiting  were  a  given 
per  cent  regardless  of  an  indefinite  substraction 
from  or  addition  to  the  supply  of  waiting,  then  that 
productivity  would,  in  a  modern  civilized  com- 
munity, fix  both  interest  and  impatience  at  its  own 
exact  per  cent.  It  means,  in  short,  that  impatience 
is  not  the  fundamental  cause  of  modern  interest 
nor  even  a  cause  through  which  all  other  causes 
must  operate,  but  that  it  is  one  of  two  coordinate 
causes  and  is  also  to  some  extent  a  joint  conse- 
quence, with  interest,  of  the  other  cause,  the 
superiority  of  indirect  production. 

It  may  be  worth  while  again  to  emphasize  the 
importance  of  a  correct  use  in  this  connection  of 
the  terms  "supply"  and  "demand."  Marginal  pro- 
ductivity is  not  to  be  looked  upon  as  having  to  do 
chiefly  with  demand  nor  is  impatience  to  be  re- 
garded merely  as  putting  a  limitation  on  supply.^" 
Neither  is  it  correct  to  regard  productivity  merely 
as  an  explanation  of  why  interest  can  be  paid  and 
impatience  as  a  reason  why  it  must  be.-^  As  we 
have  seen,  the  marginal  productivity  of  waiting 
determines  the  supply  of  present  goods,  in  the 
proper   sense    of   "supply,"    quite    as    rmich   as   it 

20  This  appears  to  be  the  view  of  Carver,  expressed  in  The  Dis- 
tribution of  Wealth,  New  York  (Macmilian),  1904,  p.  224,  and  of 
Cassel   {The  Nature  and  Necessity  of  Interest,  pp.  37,  45,  49). 

21  This  seems  to  be  the  mode  of  treatment  adopted  in  Ely,  Outlines 
of  Economics,  New  York   (Macmilian),  1908,  pp.  418,  419- 


The  Rate  of  Interest  137 

determines  the  demand;  and  impatience,  so  far  as  it 
operates  as  an  independent  cause,  affects  the 
demand  of  those  who  desire  present  goods  as  well 
as  the  supply  offered  by  those  willing  to  take 
future  goods. 

§   5 
A  Concrete  Illustration 

To  picture  concretely  the  determination  of  a 
rate  of  interest,  we  may  betake  ourselves  to  Cru- 
soe's island  after  the  addition  to  the  island's 
population  of  the  group  of  Spaniards.  The  un- 
improved land  is  valueless.  It  is  all  "marginal"  or 
"no-rent"  land.  One  acre  is  as  good  as  another  and 
the  supply  is  more  than  ample  for  all  who  live  on 
the  island. 

But  on  part  of  the  land,  Crusoe  has  made  valu- 
able improvements.  Among  other  things  there  are 
some  trees  of  a  certain  sort,  which  yield  nutritious 
fruit  once,  a  year  after  being  planted,  and  then 
die."  On  an  average  there  are  110  of  the  fruit  to 
a  tree.  Young  trees,  suitable  for  planting,  grow 
on  a  neighboring  island,  as  does  also  the  fruit. 
This  other  island  is  not  a  suitable  place  for  a 
permanent  habitation.  But  it  can  be  availed  of 
for  its  products,  and  can  be  reached  from  Crusoe's 
island,  except  at  high  tide,  by  fording.  At  first, 
Crusoe  went  to  the  neighboring  island,  at  picking 

22  This  assumption  is  made  only  for  simplicity.  It  is  apparent 
that  the  principles  involved  would  be  no  different  on  the  supposition 
of  (say)  a  thirty-year  life  and  a  yield  each  year  after  the  tenth. 
But  90  complicated  an  illustration  of  the  principle  would  make  the 
argument  more  difficult  to   follow. 


138        Earned  and  Unearned  Incomes 

time,  for  the  fruit  of  these  trees.  But  he  soon 
found  that  it  took  him  10  trips  to  bring  over,  with 
considerable  effort,  1,000  of  the  fruit,  because  of 
his  limited  carrying  capacity;  while  10  trips  or,  all 
things  considered,  an  amount  of  labor  equivalent 
to  that  required  to  bring  1,000  of  the  fruit,  would 
enable  him  to  bring  over  and  plant  10  young  trees. 
The  next  year  these  would  yield,  altogether,  1,100 
of  the  fruit.  Conditions  of  moisture,  fertility,  etc., 
are  such  that  the  trees  have  to  get  their  start, 
as  seedlings,  on  the  neighboring  island.  Hence  a 
new  supply  has  to  be  secured  each  year.  But, 
though  it  involves  a  year  of  waiting,  the  same 
amount  of  labor  yields  Crusoe  10  per  cent  more  by 
this  roundabout  method  than  by  the  direct. 

Enter  now  one  of  the  Spaniards.  Crusoe  has 
just  planted  his  year's  crop  of  10  trees.  The 
Spaniard,  who,  in  order  to  accumulate  some  capital 
of  his  own,  is  doing  more  work  than  is  necessary  to 
satisfy  his  present  needs,  would  like  to  buy.  Crusoe 
demands  payment  in  terms  of  the  kind  of  fruit  the 
trees  yield.  One  year  hence  the  trees  will  yield 
1,100  of  the  fruit  without  appreciable  further  labor. 
How  much  of  the  fruit  are  they  now  worth?  How 
much  will  the  Spaniard  give?  How  little  will 
Crusoe  take?  Is  the  question  solely  one  of  time- 
preference  with  each,  or  is  something  else  involved 
in  this  valuation  of  capital? 

We  may  begin  with  the  Spaniard.  His  position 
is  analogous  to  that  of  a  lender.  If  he  buys  the 
trees,  he  will  be  giving  up  present  fruit  for  future 
fruit.  What  is  the  most  he  will  give?  He  will 
be  guided  in  his  decision  by  two  considerations. 
One  of  these  is  his  impatience  or  time-preference. 


The  Rate  of  Interest  13^ 

The  other  is  the  cost-of-production    (in  the  place 
desired)    of  the  trees.     If  he  dislikes  to  sacrifice 
present  goods  for  future  unless  he  gets  a  return 
of    (say)    5   per   cent,   he   certainly   will   not   give 
1,100  of  the  fruit  now  for  1,100  a  year  from  now. 
Even   after  he   has   gathered   enough    fruit,    from 
the  neighboring  island,  to  buy  the  trees,   he   will 
refuse  to  buy  them  at  any  price  above  1,048,  and 
this    refusal   may   be   due   to    his   time-preference. 
But  will  he  give   1,048  if  and  because   his   impa- 
tience is  only  5  per  cent?     By  no  means.     For  he 
has  to  deal  with  the  fact  that  the  same  number 
of  trips  to  the  neighboring  island   and  the   same 
amount  of  labor,  which  will  yield  him  1,000  pieces 
of  fruit,  would  get  him  10  trees  and  plant  them. 
If  he  has  to  pay  Crusoe  1,048  pieces  of  fruit,  he 
must  work  harder  and  make  more  trips,  to  get  the 
means  of  buying  the  trees  from  Crusoe,  than  to  get 
trees    directly.      He,    therefore,    however    low    his 
rate  of  time-preference,  will  refuse  to  pay   more 
than  1,000  fruit  for  10  trees,  so  long  as  he  can  get 
and  plant  10  trees  for  himself  with  the  same  labor 
as  is  required  to  get  the  1,000  fruit.  His  refusal  to 
give   more   than    1,000    is   not   due   to   high    time- 
preference  for  present  goods  but  to  his  desire  to 
get  future  goods  in  the  cheapest  way  possible.     It 
is  not  time-preference  at  all,  but  a  choice  between 
two  different  amounts  of  present  labor,  yielding  the 
same  future  result.    This  is  the  sense  in  which  the 
value  of  capital   depends   upon   cost-of-production. 
The  value  of  the  trees  cannot  go  above  that  amount 
of  other  goods  which  requires  the  same  labor  to  get 
directly,  as  the  trees  do.     The  goods  which  could 
be  got  directly  with  the  same  labor  and  which  must 


140        Earned  and  Unearned  Incomes 

be  sacrificed  for  the  present  if  the  trees  are  directly 
got  instead,  may  be  regarded,  in  an  entirely 
proper  sense,  as  the  cost-of -production  of  the  trees. 
The  essential  fact  is,  then,  that  the  prospective 
purchaser  of  capital  has  a  choice  among  not  less 
than  three  lines  of  action  and  not  between  two 
only.  He  is  not,  as  the  time-preference  theorist 
would  have  us  believe,  restricted  to  a  choice  between 
the  present  fruit  and  the  future  fruit.  Instead,  he 
can  have  the  present  (i.  e.,  the  early  or  this 
year's)  fnait,  or  he  can  have  next  year's  fruit  from 
the  purchased  trees,  or  he  can  have  next  year's 
fruit  from  trees  which  his  own  labor  procures. 
Not  only  the  preference  for  present  (or  early)  con- 
sumption will  cause  him  to  refuse  to  pay  a  too 
high  price  for  Crusoe's  trees;  but  also  his  other 
alternative  of  producing  (in  the  economic  sense  of 
producing — in  this  illustration,  place  utilities) 
the  trees  by  his  own  labor,  will  cause  him  to 
refuse  to  pay  a  too  high  price  in  the  other  possible 
products  of  such  labor. 

We  reach  a  parallel  conclusion  if  we  suppose  that 
the  Spaniard,  instead  of  buying  trees  of  Crusoe  the 
capitalist,  employs  Crusoe  as  a  laborer  to  get  the 
trees,  paying  him  in  present  fruit.  The  Spaniard 
will  not  be  willing  to  pay  Crusoe  more  than  1,000 
fruit  for  the  labor  of  getting  or  planting  10  trees. 
Rather  than  pay  wages  appreciably  higher,  he 
would  himself  get  and  plant  the  trees  desired.  To 
be  an  employer  of  labor,  advancing  present  con- 
sumable goods  for  durable  capital,  he  must  produce 
present  goods  in  excess  of  his  own  present  needs. 
But  he  has  the  alternative  of  devoting  his  surylus 
time,  instead,  to  the  production  of  durable  capital 


The  Rate  of  Interest  141 

which  ivill  serve  his  future  needs.  This  possible 
alternative  will  make  him  unwilling,  however  low 
his  time-preference,  to  accumulate  present  goods 
for  the  payment  of  wages,  unless  his  future  return 
from  so  doing  is  equally  large. 

Likewise,  if  we  suppose  him  to  lend  to  Crusoe, 
the  rate  at  which  he  will  lend  is  influenced  directly 
by  his  other  alternative,  and  not  merely  by  his 
time-preference  or  by  his  other  alternative  acting 
through  the  intermediation  of  time-preference.  He 
will  not  lend  Crusoe  1,000  fruit  this  year  for  much 
less  than  1,100  next  year,  however  low  may  be  his 
time-preference,  because  the  labor  necessary  to 
secure  him  the  surplus  1,000  this  year  above 
present  needs  will,  if  turned  to  more  roundabout 
production,  yield  him  a  return  next  year  of  1,100. 
He  would  rather  get  1,100  next  year  as  a  result 
of  this  year's  labor  in  roundabout  production,  than 
to  get  less  than  1,100  next  year  as  a  result  of  this 
year's  labor  in  supplying  Crusoe's  present  needs. 
There  is  no  intention  to  deny  that  the  surplus 
productivity  of  roundabout  production  also 
influences  time-preference,  by  influencing  the  rela- 
tive endowments  of  present  and  future.-^  Neither 
is  there  any  intention  to  deny  that  the  rate  of 
time-preference,  by  influencing  the  extent  to  which 
roundabout  production  is  carried,  aff"ects  the 
marginal  gain  from  such  production.  The  rate  of 
interest  fixed  by  market  competition  will  also  be 
the  rate  of  time-preference  and  the  rate  of  surplus 
productivity    of    roundabout    production.      But    to 

23  See    Bohm-Bawerk,    Posithe     Tluorie    des    Kapitales,    Dritte 
Auflage    (Innsbruck,   1912),  p.  468. 


142        Earned  and  Unearned  Incomes. 

assert  this   is  not  to   assert  that  time-preference 
is   the    sole    proximate    cause    and    that    all    other 
causes  must  act  through  it.    As  we  have  just  seen, 
the    rate    of    productivity    influences    directly    the 
supplier  of  present  goods;  and  the  cost-of -produc- 
tion   of   capital,    in   the    sense   here    used,    has    a 
direct  influence  on  the  demander  of  such  capital. 
Suppose,  now,  we  turn  to  Crusoe's  side  of  the 
market,    the    side    of    the    person    who    purchases 
present  goods  with  future.     What  determines  the 
price  at  which  Crusoe  will  dispose  of  his  10  trees, 
or  rather,  since  this  is  the  important  question  in 
the  long  run  for  capital  valuation,   at  what  price 
in  present  fruit  will  Crusoe  be  willing  to  engage  in 
the  business  of  getting,  planting,  and  selling  trees? 
Crusoe,  we  may  suppose,  is  now  permanently  on  the 
present  goods  side  of  the  market.    He  is  no  longer 
accumulating    capital    and    has,    perhaps,    lost    or 
dissipated  what  he  had.     If  he  produces  durable 
capital,  it  is  only  to  dispose  of  it  for  present  con- 
sumable goods.     Let  it  be  understood  that  we  are 
not  assuming  Crusoe  to  be  a  middleman.     On  the 
contrary,  he  is  here  the  "ultimate  consumer."    But 
he  is  also  a  producer.     He  wants  present  goods, 
present  fruit.    To  get  this  fruit,  he  must  either  go 
to  the  neighboring  island  and  bring  it  over  or  he 
must  buy  it  of  somebody  else  by  offering  future 
goods.     Once  he  has  produced  these  future  goods, 
i.  e.,  secured  and  planted  the  10  trees,  time-prefer- 
ence may  alone  decide  at  what  rate  he  will  exchange 
them  for  present  fruit.     But  before  he  turns  his 
labor  in  that  direction,  he  will  consider  whether  he 
can  get  more  present  fruit  by  producing  durable 
capital  to  buy   it   with   or  by  devoting  the   same 


The  Rate  of  Interest.  143 

labor  to  getting  the  present  fruit.  Year  in  and 
year  out  Crusoe  will  not  maintain  the  supply  of 
more  durable  capital,  i.  e.,  will  not  produce  it  for 
sale,  except  at  a  price  which  is  as  satisfactory  to 
him  as  the  yield  of  direct  production  of  present 
goods.  The  labor  necessary  to  get  the  10  trees  is 
the  same,  on  our  hypothesis,  as  the  labor  necessary 
to  get  1,000  pieces  of  the  fruit.  The  10  trees, 
planted  near  by,  yield  next  year  1,100  pieces  of 
fruit. 

Crusoe's  rate  of  time-preference  of  course  fixes 
a  minimum  below  which  he  will  not  sell  the  trees. 
If  his  rate  of  time  preference  is  15  per  cent,  he  will 
not  sell  them  for  less  than  956  fruit,  because  he 
would  rather  wait  for  the  1,100  future  fruit.  But, 
in  the  long  run,  his  minimum  price  is  fixed  by  two 
considerations  and  not  by  one  only.  The  second 
consideration  is  his  alternative  of  directly  producing 
the  fruit  by  going  to  the  neighboring  island  after 
it.  Year  in  and  year  out,  he  will  not  bring,  plant, 
and  sell  the  trees  for  less  than  1,000  of  the  fruit. 
If  he  cannot  secure  approximately  that  price  for 
the  trees,  he  will  get  the  fruit  directly  instead  of 
trading  for  it.  The  possibility  of  his  doing  so 
will  itself  tend  to  keep  the  trees  scarce  enough  to 
yield  that  price  in  terms  of  the  fruit.  In  other 
words,  he  will  not  sell  the  trees  for  less  than  their 
cost-of-production  measured  by  the  other  goods 
which  the  same  work  would  produce. 

Our  conclusion  is  no  different  if  we  assume  him 
to  sell  his  services  as  a  laborer,  for  wages,  instead 
of  selling  the  trees.  He  will  not  work  for  the 
Spaniard  at  the  job  of  getting  and  planting  trees, 
for  a  less  wage  in  present  fruit  than  the  amount 


144        Earned  and  Unearned  Incomes. 

of  present  fruit  which  the  same  labor  would  give 
him  if  applied  directly  to  bringing  the  fruit  from 
the  other  island. 

But  instead  of  selling  trees  for  present  fruit  or 
working  for  wages  in  present  fruit,  Crusoe  may 
borrow  present  fruit  to  pay  it  back  next  year. 
Here,  also,  if  he  is  a  productive  borrower,  he  is 
not  simply  comparing  present  and  future  benefits. 
If  he  has  no  accumulations  and  if,  also,  it  re- 
quires all  his  present  labor  to  provide  for  his 
present  needs,  Crusoe  must  needs  engage  in  direct 
production  unless  he  can  borrow.  If  he  can 
borrow^  1,000  present  fruit,  he  is  relieved  from  the 
necessity  of  getting  fruit  now  for  present  needs 
and  can  get  the  trees  instead.  But  more  than 
1.100  fruit  next  year  for  1,000  fruit  this  year,  he 
will  not  give,  since  the  former  represents  Tnore 
present  labor  than  the  latter.  Only  an  unproductive 
borrower  would  make  such  a  contract  and  he  would 
soon  be  eliminated  from  the  market.  On  the  other 
hand,  however  low  might  be  his  time-preference, 
Crusoe  would  still  be  willing  to  borrow  at  any  rate 
of  interest  less  than  10  per  cent.  To  do  so  would 
leave  him  as  well  off  in  the  present  and  better  off 
in  the  future.  He  would  borrow  at  less  than  10  per 
cent  because  to  do  so  would  give  him  a  larger 
future  income  than  not  to  do  so.  His  comparison 
would  be  between  tivo  futures,  rather  than  between 
a  present  and  a  future. 

Let  us  now  turn  again  to  the  distinction  between 
land  and  capital.  The  distinction  is  not,  strictly, 
one  between  land  and  all  other  capital.  It  is  a 
distinction  rather  between  reproducible  and  non- 
reproducible  goods.     The  paintings  of  old  masters 


The  Rate  of  Interest.  145 

and  business  sites  in  New  York  City  are  in  the 
same  category.  For  all  practical  purposes,  they 
cannot  be  reproduced.  It  is  not  intended  to  argue 
that  there  is  no  "made  land"  or  that  land  owes 
none  of  its  value  to  work  upon  it.  But  so  far  as 
its  characteristics  cannot  be  reproduced,  the  value 
of  land  is  not  limited  by  its  cost-of-production. 
Crusoe  could  not  sell  his  10  trees  for  more  than 
1,000  pieces  of  fruit,  for  that  was  their  equivalent 
of  their  cost-of-production.  But  if  the  island  were 
crowded,  and  there  were  no  practical  possibility  of 
adding  to  the  land,  no  such  definite  limit  would 
determine  a  minimum  price  of  the  land  in  terms 
of  other  goods.  The  value  of  this  land  could  be 
arrived  at  only  by  discounting  the  prospective 
value  of  its  future  yield.  The  value  of  reproducible 
capital  is  influenced  by  tivo  considerations;  that  of 
capital  not  reproducible,  by  one. 

§   6 
Interest  in  a  Moyiey  Economy 

It  should  not  be  difficult  to  translate  our  results 
into  terms  of  a  money  and  money  price  economy.  In 
such  an  economy,  fruit  or  other  consumption  goods 
would  not  be  directly  borrowed.  The  borrower 
would  seek,  instead,  the  amount  of  money  necessary 
to  purchase  such  goods.  Trees  would  not  be 
directly  traded  for  fruit  nor  would  the  labor  of 
planting  trees  be  paid  for  in  fruit.  Instead,  the 
seller  of  trees  or  fruit  or  labor  would  receive 
money  and  the  buyer  would  pay  money.  But  the 
ultimate  result  would  be  the  same  since  the  seller 
of  one  good  is  the  buyer  of  another.     In  order  to 


146        Earned  and  Unearned  Incomes. 

make  plausible  the  assumption  of  a  money  economy 
on  Crusoe's  island,  let  us  suppose  its  population  to 
have  materially  increased  so  that  others  than  Cru- 
soe and  the  Spaniard  are  engaged  in  productive 
effort.  The  Spaniard  now  will  not  pay  for  Crusoe's 
10  trees  more  money  than  he  can  get  for  his  1000 
pieces  of  fruit.  He  might  better,  himself,  become 
a  producer  of  trees  and  let  Crusoe  or  others  go 
after  fruit.  Likewise,  Crusoe  will  not  intentionally 
produce  the  10  trees  for  sale  at  a  lower  price  in 
money  than  could  be  realized  by  the  sale  of  1000 
pieces  of  the  fruit.  So,  also,  if  the  Spaniard  con- 
templates borrowing,  not  the  1000  pieces  of  fruit 
necessary  to  support  life  while  fetching  and  plant- 
ing the  trees,  but  the  amount  of  money  necessary 
to  buy  the  fruit,  he  will  not  consent  to  repay 
more,  as  principal  and  interest,  than  the  expected 
money  value,  next  year,  of  the  1100  pieces  of 
fruit  which  his  present  efforts  will  then  yield  him. 
Nor  will  Crusoe,  as  a  lender,  consent  to  take  much 
less,  since  he  might  rather  himself  expend  his 
money  for  the  fruit  which  he  would  then  not  have 
to  produce  to  satisfy  his  present  desires.  By  so 
doing  Crusoe  would  be  relieved  of  the  necessity 
of  gathering  fruit,  would  be  able  to  plant  trees 
instead,  and  could  secure,  next  year,  the  reward 
of  his  roundabout  production.  With  the  use  of 
money  or  without  it,  the  rate  of  productivity  of 
waiting  is  an  important  determinant  of  interest. 
If  the  relative  difficulty  of  producing  fruit  directly 
and  of  producing  trees  remains  unchanged  during 
the  year,  that  is,  if  the  per  cent  marginal  return 
to  waiting  in  the  industry  in  question  is  constant, 
then  the  relative  money  prices  of  fruit  and  trees 


The  Rate  of  Interest.  147 

will  remain  unchanged.  Unless,  therefore,  the 
money  prices  of  both  change,  the  percent  gain 
from  roundabout  production,  measured  in  money, 
and  the  rate  of  interest  realized  in  money,  will  be 
the  same,  respectively,  as  the  per  cent  gain  and  the 
rate  of  interest  realized  in  fruit.  In  a  later 
section-*  reference  will  be  made  to  some  of  the 
effects  of  the  fluctuating  value  of  money.  But  these 
effects,  though  they  may  lead  us  to  qualify,  will 
not  lead  us  to  cast  aside  the  results  of  the  fore- 
going analysis.  The  connection  of  the  surplus 
productivity  of  roundabout  processes  as  a  cause 
with  the  rate  of  interest  as  an  effect  is  too 
fundamental  to  be  successfully  controverted. 

§  7 
Changing   Bank  Reserves   in  Relation   to   Interest 

A  large  amount  of  money  carries  with  it  in  a 
modern  country,  a  large  amount  of  bank  credit. 
A  part  of  the  money  in  a  modern  community  takes 
the  form  of  bank  reserves,  and  the  credit  which 
banks  can  lend  with  safety  is  a  more  or  less 
definite  multiple  of  these  reserves.  Also,  as  a 
matter  of  business  convenience,  individuals  and 
corporations  preserve  a  more  or  less  definite 
ratio  between  their  cash  assets  and  their  checking 
or  commercial  bank  credit  accounts.-^  If,  there- 
fore, the  quantity  of  money  should  double,  we  might 
very  reasonably  expect  the  volume  of  bank  credit 
to  double  likewise,  and  prices  to  double.     The  new 

2*  §3. 

25  See  Fisher,  The  Purchasing  Po<wer  of  Money,  New  York  ( Mac- 
millan),   1913,  pp-   50-52. 


148        Earned  and  Unearned  Incomes. 

condition  of  equilibrium,  when  reached,  would  be 
one  in  which  the  amount  of  money  in  circulation, 
the  volume  of  bank  credit,  and  the  amount  of 
money  in  bank  reserves,  were  all  larger  in  the 
same  proportion  (double)  and  in  which,  therefore, 
these  quantities  had  the  same  ratios  each  to  each 
as  before  the  increase."^'  With  a  large  quantity 
of  money,  interest  would  be  the  same  as  if  there 
were  less  money-^  and  with  a  change  in  the 
quantity  of  money  interest  would  eventually  be  the 
same  as  if  the  quantity  of  money  had  not  changed. 
But  with  a  change  in  the  quantity  of  money  there 
are  likely  to  be  certain  disturbing  transitional 
effects  on  the  loan  rate  of  interest,  to  which  at 
least  brief  consideration  ought  to  be  devoted. 

When  the  amount  of  money  increases  rapidly 
and  largely,  the  new  money  goes  at  first,  for 
the  most  part,  into  the  banks.  If  it  comes  from 
the  mines,  the  mine  owners  can  do  little  else  than 
deposit  it.  Even  if  they  put  the  money  into 
various  investments,  the  receivers  of  the  money 
can  do  little  else  than  deposit  it  in  commercial 
banks.  They  may  choose  to  use  a  fifth  or  a 
tenth  of  it  as  money  in  current  transactions,  but 
they  will  probably  prefer  for  their  larger  trans- 
actions to  use  checks.  Hence  bank  reserves  are 
pretty  likely  to  be  increased,  at  the  start,  more 
than    money   in   circulation   outside   the   banks   is 

2*  Assuming,  of  course,  that  other  conditions  did  not  meanwhile 
so  change  as  to  make  a  new  equilibrium  the  normal  one. 

2"  The  notion  that  loan  interest  would  be  reduced  because  there 
would  be  more  money  to  lend,  comes  from  overlooking  the  fact  that 
with  higher  prices  correspondingly  more  must  be  borrowed.  See 
Fisher,   The  Rate  of  Interest,  New  York    (Macmillan),   1907,  p.   8. 


The  Rate  of  Interest.  149 

increased.  The  case  is  substantially  similar  when 
gold  flows  into  any  one  country  from  abroad. 
During  two  years  of  the  present  world  war,  while 
the  United  States  was  neutral,  a  tremendous 
■excess  of  exports  from,  over  imports  to,  the 
United  States  brought  a  very  large  inflow  of 
gold.  But  the  exporters  did  not  want  the  balances 
due  them  in  the  form  of  gold  or  money.  They 
desired  some  money  but  mostly  checking  accounts. 
They  sold  to  the  banks  their  drafts  on  the  foreign 
purchasers  of  American  goods,  and  accepted 
credit  accounts  with  the  banks  and  such  cash  for 
small  transactions  as  they  needed.  The  banks 
received  the  imported  gold.  The  ratio  of  money 
in  banks  to  money  in  circulation  was  large;  the 
ratio  of  bank  reserves  to  bank  deposits  (checking 
accounts)  was  larger  than  would  otherwise  prob- 
ably have  been  the  case.  There  were  said  to  be 
surplus  bank  reserves. 

Of  course  this  condition  is  not  permanent.  The 
larger  reserves  must  eventually  mean  more  bank 
credit,  i.  e.  a  larger  volume  of  checking  accounts. 
The  larger  volume  of  bank  credit  must  mean 
larger  cash  withdrawals.  As  we  have  just  seen, 
the  eventual  new  condition  of  equilibrium  is  one 
of  increased  money  in  circulation,  proportionately 
increased  bank  reserves,  proportionately  increased 
bank  credit,  and  higher  prices.  But  how  does  all 
this  come  about?  Must  it  not  be  through  a  bank 
discount  (interest)  rate  sufficiently  favorable  to 
encourage  borrowing?  The  banks  have  excess 
reserves  and,  therefore,  large  lending  power.  It 
is  their  particular  business  to  make  loans,  and  it 
is  more  profitable  for  them  to  loan  at  fairly  low 


150        Earned  and  Unearned  Incomes. 

rates  than  for  them  to  hold  excessive  idle  reserves. 
Gradually  the  favorable  rate  on  loans  encourages 
borrowing,  bank  credit  expands,  prices  rise  and, 
when  bank  reserves  are  no  longer  in  excess,  bank 
discount  (interest)  rates  rise  also.  So,  too,  bank 
discount  (interest)  fluctuates  with  the  change 
from  business  depression  to  business  activity  as 
bank  reserves  are  alternately  excessive  and  barely 
adequate.  The  ultimate  long  run  influences  on  the 
rate  of  interest  are  those  we  have  discussed  in 
the  previous  chapter  and  the  preceding  sections 
of  this  chapter.-"  But  the  fluctuations  in  the  loan 
rate  are  closely  connected  with  the  fluctuations  in 
general  business  activity,  seasonal  changes,  changes 
in  the  quantity  of  money  and,  going  along  with 
these  or  because  of  these,  changes  in  the  per  cent 
of  bank  reserves  to  bank  deposits  (checking 
accounts) . 

An  increased  quantity  of  money  in  bank  reserves 
may  not  for  several  months  or,  perhaps,  even 
years,  bring  about  the  eventual  corresponding 
increase  in  bank  credit  and  the  incident  rise  of 
prices.  The  borrowing  business  man  has,  ordinarily, 
a  certain  notion  of  how  much  business  he  wishes 
to  do  and  how  large  a  stock  of  goods  or  how  much 

28  To  which  should  be  added,  the  influence  of  the  sporadic  wait- 
ing made  available  by  the  institution  of  commercial  banking,  which 
places  at  the  disposal  of  borrowers  funds  of  depositors  which  would 
otherwise  be  idle  for  various  indeterminate  periods  and  tends  thus 
somewhat  to  reduce  the  marginal  productivity  of  waiting.  More 
capital  of  other  sorts  can  be  produced  because  credit  has  been  substi- 
tuted for  the  more  expensive  specie.  But  marginal  productivity 
remains  a  determining  force  in  fixing  interest.  See  the  author's 
Principles  of  Commerce,  New  York  (Macmillan),  1916,  Part  I, 
Chapter  II,  §§  3,  4  and  5- 


The  Rate  of  Interest.  151 

labor  he  wants  to  buy.  To  carry  out  his  plans  he 
needs  a  certain  amount  of  funds  larger  or  smaller 
according  to  the  prices  of  what  he  has  to  buy. 
Until  bank  credit  has  expanded  proportionately  to 
the  increase  of  money,  prices  will  not  rise  in  the 
degree  to  be  eventually  expected.  But  until  prices 
do  so  rise,  the  business-man  borrower  does  not  need 
to  seek  much  more  than  his  ordinary  credit  to  carry 
on  his  ordinary  business.  The  level  of  prices  de- 
pends largely  upon  the  volume  of  bank  credit  but 
the  amount  of  bank  credit  depends  in  considerable 
measure  upon  the  level  of  prices.  Nevertheless  we 
are  not  absolutely  caught  in  an  endless  circle. 
Favorable  discount  rates  will  encourage  business 
men  to  borrow  and  endeavor  to  expand  their  busi- 
ness. But  when  the  industrial  world  is  fully  oc- 
cupied, the  endeavor  of  its  different  units  to  expand 
can  hardly  result  in  a  general  expansion.  Different 
business  men  bid  against  each  other  for  labor,  for 
raw  materials,  for  structural  goods,  and  prices  rise. 
The  rise  of  prices  necessitates  more  borrowing, 
even  if,  in  individual  cases,  there  is  no  expansion. 
The  favorable  discount  rates  still  encourage  to  at- 
tempted expansion  and  to  the  further  borrowing 
which  such  expansion  implies.  At  length  per  cent 
reserves  are  reduced,  credit  is  expanded  to  its  nor- 
mal ratio  to  reserves  and  to  money  in  circulation, 
prices  are  high,  and  men  must  borrow  largely  to 
do  an  ordinary  business  at  these  high  prices.  In- 
terest rises,  and,  if  bank  reserves  become  inade- 
quate or  nearly  so,  may  have  to  rise  to  a  point  as 
much  above  its  usual  level  as  it  previously  was  be- 
low. We  may,  however,  think  of  these  various 
changes  in  bank  discount  rates  as  fluctuations  above 


152        Earned  and  Unearned  Incomes. 

and  below  an  average  or  normal  rate.  Further- 
more, the  bank  discount  rate  is  purely  a  loan  rate. 
It  is  not  necessarily  the  rate  at  which  present 
goods  and  future  exchange  for  each  other  when 
capital  instruments  are  sold.  It  is  not  necessarily, 
in  other  words,  the  same  as  the  rate  of  return  real- 
ized by  the  owners  of  capital,-'^  although  it  tends, 
in  the  long  run,  to  approximate  that  rate.  When 
loan  interest  is,  for  any  such  special  reason  as  in- 
creased bank  reserves,  temporarily  abnormally  low, 
this  does  not  mean  that  the  interest  earned  by  capi- 
tal is  low  but  only  that  borrowers  are  profiting  at 
the  expense  of  lenders,  realizing  large  or  moderate 
returns  on  the  capital  of  others  and  paying  low 
rates  for  the  privilege. 

§  8 

Rising  and  Falling  Prices  in  Relation  to  Interest 

To  illustrate  the  relation  of  rising  and  falling 
prices  to  the  interest  problem,  let  us  take  the  case 
of  a  man  who,  for  $6,000,  buys  a  house.  If,  as  a 
consequence  of  increasing  gold  production  or  ex- 
pansion of  credit  or  both,  prices  rise,  in  five  years, 
by  50  per  cent,  and  if  this  rise  is  a  general  one 
applying  to  houses  as  well  as  to  other  things,  then 
his  house,  at  the  end  of  five  years,  will  be  worth 
$9,000.^''  The  owner  will  have  had  the  annual  use 
of  the  house,  or  its  annual  rent  at  a  progressively 
higher  rate,  and  can  now  sell  it  for  an  increase  of 
50  per  cent  over  the  purchase  price.    Nevertheless, 

2®  In  excess  of  their  wages  of  management. 
^°  Making  no  allowance  for  depreciation. 


The  Rate  of  Interest.  153 

on  the  supposition  that  other  prices  have  gone  up 
in  like  ratio  he  is  no  better  off  than  before.  He 
has  50  per  cent  more  money  than  he  otherwise 
would  but  also  the  things  he  wants  to  buy  cost  50 
per  cent  more.  Similarly,  if  prices  fell,  so  that  his 
house  would  sell  for  only  2/3  of  the  purchase  price, 
or  $4,000,  this  fall  would  carry  with  it  no  loss, 
since  the  $4,000  would  buy  as  much  at  the  lower 
prices  as  the  $6,000  would  originally  buy. 

But  with  prices  rising  the  annual  money  rents 
received  for  the  use  of  the  house,  if  rented,  would 
come  to  be  a  larger  per  cent  of  its  original  cost; 
while  with  prices  falling  they  would  become  a 
smaller  per  cent.  The  actual  gain  on  investment 
may  be  the  same  in  either  case,  but  the  gain  meas- 
ured in  money  bears  in  one  case  a  larger  and  in 
the  other  case  a  smaller  ratio  to  the  original  money 
value  of  the  property.  Hence,  in  a  nominal  sense, 
the  interest  received  by  the  directing  owner  of 
capital  is  higher  in  periods  of  rising  prices  and 
lower  in  periods  of  falling  prices.  It  should  be  em- 
phasized that  the  interest  here  in  question  is  the 
"implicit"''^  interest  received  by  investors  who  di- 
rectly purchase  income-yielding  capital;  "explicit" 
or  loan  interest  is  not  meant. 

A  consideration  of  the  rate  of  interest  on  loans 
in  a  period  of  rising  or  one  of  falling  prices,  raises 
the  question  of  the  relative  gain  or  loss  from  price 
changes  of  the  borrower  and  the  lender.  Let  us 
turn  again  to  the  hypothesis  of  a  50  per  cent  rise 
of  prices  and  its  effect  on  the  purchaser  of  a  $6,000 
house;  but  let  us  now  assume  that  $4,000  was  bor- 

31  A  term  used  by  Fisher,  T/ze  R<.lc'  of  hiteresi.  pp.  lo  and  ii. 


154        Earned  and  Unearned  Incomes. 

rowed  at  (say)  6  per  cent  interest,  the  principal 
to  be  repaid  in  five  years.  In  the  meanwhile  the 
lender  receives  $240  a  year  (6  per  cent  of  $4,000), 
which  the  borrower  can  presumably  pay,  while  still 
making  something  for  himself,  out  of  the  gradually 
rising  rent  of  the  house.  And  at  the  end  of  the  five 
years,  when  the  property  sells  for  $9,000,  the  titu- 
lar owner  has  to  pay  only  $4,000  to  the  person  who 
made  the  loan,  $4,000  which  will  buy  much  less 
than  it  would  have  bought  when  lent  five  years  be- 
fore. The  titular  owner  himself  keeps  the  other 
$5,000,  a  sum  which  makes  good  his  personal  in- 
vestment of  $2,000,  together  with  the  loss  from 
the  depreciation  of  money,  and,  in  addition,  gives 
him  a  substantial  profit  at  the  expense  of  the  lend- 
er. Had  the  lender  been  familiar  with  the  fact 
that  money  is  not  constant  in  value,  had  he  fore- 
seen the  rise  of  prices,  and,  having  the  alternative 
of  himself  investing  his  money  in  a  house  or  other- 
wise, had  he  refused  to  lend  except  for  an  interest 
return  enough  above  the  6  per  cent  to  compensate 
him  for  the  depreciated  value  of  the  money  he 
would  later  receive,  the  borrower  would  not  have 
been  able  thus  to  gain  at  his  expense.  Indeed,  as 
Professor  Fisher  has  shown, ^'-  there  is  some  ten- 
dency for  rising  prices,  if  long  continued,  to  in- 
crease the  rate  of  interest  paid  on  loans,  because, 
although  the  depreciation  of  money  may  not  be 
consciously  recognized  as  such,  yet  the  profits  of 
extending  investment  on  borrowed  money  during 
such  a  period  of  rising  prices  are  so  tempting  as 
appreciably  to  increase  the  demand  for  loans  and, 

22  The  Rate  of  Interest,  Chapter  XIV. 


The  Rate  of  Interest.  155 

probably,  to  decrease  the  supply.  More  persons 
wish  to  borrow  in  order  to  invest.  Fewer  persons 
wish  to  lend  for  the  investment  of  others.  There 
is  likely  to  be,  therefore,  when  the  rise  of  prices  is 
at  all  prolonged,  a  marked  tendency  for  loan  in- 
terest to  go  up. 

The  statement  that  rising  prices,  if  long  enough 
continued,  cause  the  rate  of  loan  interest  measured 
in  money  to  rise,  should  not  be  regarded  as  incon- 
sistent with  the  view  previously  presented'^  that  a 
large  and  rapid  increase  in  the  amount  of  money 
is  likely,  at  first,  to  reduce  the  bank  rates  of  dis- 
count by  creating  large  reserves.  The  higher  rate 
of  interest  on  loans  should  be  regarded  as  a  later 
effect  of  increasing  money.  The  probable  sequence 
would  be:  increase  of  money;  increase  of  bank 
reserves;  low  discount  rates  on  loans  from  com- 
mercial banks ;^*  expansion  of  bank  credit;  rising 
prices;  rising  interest  and  discount  rates. 

On  the  other  hand  a  fall  of  prices  such  that  in 
five  years  the  house  and  lot  of  our  illustration 
would  sell  for  only  $4,000  instead  of  the  $6,000 
originally  paid  for  it  would  mean,  not  only  that 
the  lender  would  get  his  $240  a  year  regardless  of 
the  fact  that  the  rent  of  the  house  was  progressive- 
ly declining,  but  also  that  at  the  end  of  the  five 
years  the  house  and  lot  would  sell  for  barely  enough 
to  pay  him  his  principal.  His  $4,000,  however, 
would  buy  very  considerably  more  than  the  $4,000 
he  lent,  while  the  borrower's  $2,000  margin  would 
be  reduced  to  nothing.     Falling  prices,  therefore, 

33  §  7  of  this  Chapter   (V). 

"•»  Influencing,    of    course,    the    general    rate    of    interest    on    Innns. 


156        Earned  and  Unearned  Incomes. 

call  for  and,  in  the  long  run,  probably  bring,  lower 
rates  of  money  interest^^  to  compensate  for  the 
greater  difficulty  of  repaying  the  principal.  But 
changes  in  the  value  of  money  are  inadequately 
realized  and  seldom  accurately  foreseen,  and  it 
therefore  follows  that  the  relations  between  borrow- 
ers and  lenders  are  seriously  disturbed  by  such 
changes.  A  money  and  credit  system  so  adjusted 
to  trade  as  to  keep  the  average  price  level  always 
constant  would  for  this  as  well  as  for  other  reasons 
have  advantages  over  the  present  fluctuating  cur- 
rency.^° 

§  9 

Some  Further  Complications  in  the  Actual  Indus- 
trial   World 

A  number  of  additional  refinements  must  be 
added  to  the  theory  of  interest  as  thus  far  present- 
ed, in  order  to  make  this  theory  fit  the  complica- 
tions of  actual  life.  In  the  first  place,  we  can  not 
properly  assume  for  the  real  economic  world,  as 
we  have  been  assuming,  for  the  sake  of  simplicity, 
in  much  of  the  preceding  discussion,  that  the  mar- 

^^  It  is  not  improbable  that  a  decrease  in  the  amount  of  money  or 
a  decrease  of  money  in  proportion  to  business,  would  first  show 
itself  in  comparative  insufficiency  of  bank  reserves  and  temporarily 
higher  discount  rates,  this  condition  being  followed  by  a  decrease 
or  relative  decrease  of  bank  credit  and  by  falling  prices,  and  the 
falling  prices  leading  to  a  decrease  of  demand  for  loans  and,  hence, 
to  a  lower  rate  of  interest  on  money. 

36  See  The  Purchasing  Poiver  of  Money,  by  Irving  Fisher,  assisted 
by  Harry  G.  Brown,  New  York  (Macmillan),  1913,  Chapter  XIII, 
for  a  discussion  of  various  methods  of  making  the  price  level  more 
stable. 


The  Rate  of  Interest  157 

ginal  gain  from  roundabout  production  will  be  alike 
10  per  cent  or  5  per  cent  or  any  per  cent  for  all 
actual  and  potential  producers,  without  regard  to 
whether  they  have  access  to  the  loan  market.  Ca- 
pabilities and  aptitudes  differ.  Marginal  round- 
about production  might  yield,  for  one  man,  making 
use  only  of  his  own  saving  or  waiting,  10  per  cent 
over  the  yield  of  direct  production  ;  while  for  another 
man,  making  use  of  all  his  own  waiting  and  no 
more,  the  yield  might  be  only  4  per  cent.  The 
yield  to  the  second  man  might  be  smaller  because 
he  had  saved  more  and  had  to  carry  roundabout 
production  to  a  lower  margin.  Or  it  might  be 
smaller  because  he  was  less  efficient  in  roundabout 
production  or  because  he  was  more  efficient  in 
direct  production.  In  any  such  case  both  would 
gain  by  the  possibility  of  a  loan.  If  both  have 
saved  equally  while  the  first  producer  can  gain  a 
larger  per  cent  from  roundabout  production,  the 
first  can  profitably  borrow  and  the  second  can 
profitably  lend.  So,  likewise,  if  the  second  has 
saved  so  much  that  his  waiting,  directed  by  himself, 
can  produce,  at  the  margin,  but  little  return,  it 
will  be  advantageous  to  him  to  lend  to  someone 
who  can  make  his  waiting  produce  more.  In  that 
case  he  will  not  carry  his  own  use  of  capital  to  such 
a  point  as  to  bring  the  marginal  yield  below  the 
interest  he  can  realize  by  lending.  The  first  pro- 
ducer, whether  the  large  gain  he  can  realize  from 
roundabout  production  is  due  to  his  having  saved  lit- 
tle or  to  his  being  relatively  proficient  in  directing  a 
roundabout  process,  will  find  it  worth  while  to 
borrow  at  the  prevailing  rate  and  to  carry  round- 
about  production   to   a   point   such   that  the   yield 


158        Earned  and  Unearned  Incomes 

from  its  further  extension  under  his  direction 
would  not  be  in  excess  of  the  rate  at  which  he 
could  borrow.  Thus,  the  marginal  productivity  of 
capital  or  of  waiting,  for  each  producer  who  directs 
the  use  of  capital,  tends  to  approximate  the  rate 
of  interest  at  which  he  can  lend  or  the  rate  at 
which  he  can  borrow.  If  everyone  could  give 
equally  good  security  and  could,  therefore,  borrow 
at  the  same  rate,  the  marginal  productivity  of 
waiting  would  tend  to  be  the  same  for  all  pro- 
ducers and  all  lines  of  production. 

In  the  second  place,  we  must  somewhat  qualify 
our  conclusions  regarding  the  determination  of 
the  value  of  capital,  though  not  in  such  a  way  as 
to  affect  the  main  principles  contended  for.  We 
have  said  that  interest  is  some  per  cent,  e.  g. 
6  per  cent,  because  capital  instruments  the  values 
of  which  are  measured  by  the  alternative  goods 
that  could  be  produced  by  the  same  labor,  working 
with  an  equivalent  equipment  of  land  and  tools, 
yield  6  per  cent.  Thus  a  railroad,  some  barns, 
some  mills  and  some  machinery,  taken  all  together, 
would  be  said  to  be  worth  in  the  long  run  a 
certain  amount  in  terms  of  consumable  goods  or 
of  money  exchangeable  for  such  goods,  because, 
were  they  to  be  worth  any  less,  the  labor,  etc., 
turned  to  their  construction  would  find  it  more 
profitable  to  turn,  in  part,  to  the  production  of 
consumable  goods.  In  the  real  economic  world, 
with  the  diverse  inherited  abilities  of  its  members 
and  the  diff'erent  kinds  and  degrees  of  acquired 
skill,  many  producers  practically  have  not  the 
alternative  of  changing  employments.  But  so 
many  can  change  their  employments  and  the  choices 


The  Rate  of  Interest  159 

of  those  persons  just  about  to  enter  the  ranks 
of  industry  are  so  important,  that  the  value  of 
various  kinds  of  capital  is  related,  through  their 
alternatives,  to  the  value  of  consumable  goods. 
In  like  manner  the  value  of  consumable  goods  is 
related  to  the  value  of  capital.  Since  producers  of 
one  kind  of  goods  usually  have  different  aptitudes 
than  producers  of  another  kind,  we  cannot  say 
that  the  value  of  any  capital  must  exactly  equal 
the  value  of  the  present  goods  which  the  same 
labor  or  an  identical  quantity  of  labor  would 
produce.  But  that  there  is  a  close  relation  between 
the  two,  due  to  the  existence,  for  many  producers, 
of  alternatives,  cannot  be  gainsaid.  Stating  the 
matter  roughly  and  assuming  the  above  qualifica- 
tion to  be  made,  we  may  say  that  the  (marginal") 
product  of  labor  devoted  to  the  construction  of 
capital  equipment  will  exchange  for  the  (marginal) 
product  of  an  equal  amount  of  labor  devoted  to 
the  production  of  consumable  goods. ^"^     Of  course, 

3^  For  explanation  and  more  complete  discussion  of  the  "marginal" 
product  of  labor,  see  Chapter  V'll. 

3s  If  A  buys  from  B  a  piece  of  capital  which  it  requires  (say)  a 
year  to  make,  the  price  paid  for  the  capital  will  of  course  be  dif- 
ferent according  as  the  payment  is  made  from  day  to  day  to  support 
B  while  he  is  making  it  (wages)  or  at  the  end  of  the  year  when 
it  is  complete.  In  the  former  case  A  would  be  willing  to  pay  the 
amount  of  current  goods  which  labor  equivalent  to  that  of  producing 
the  capital  could  alternatively  produce.  In  the  latter  case,  if  A  had 
contracted  at  the  beginning  of  the  year  to  buy  the  capital  of  B  at 
the  end  of  the  3ear,  the  amount  he  would  have  been  willing  to  offer 
would  be,  not  the  amount  of  goods  he  could  have  currently  produced 
by  a  direct  process  but  the  amount  he  could  have  produced  by  the 
most  effective  roundabout  process  available  which  would  neverthe- 
less yield  its  entire  product  by  the  end  of  the  year.     But  if  A  does 


160        Earned  and  Unearned  Incomes 

also,  if  capital  of  any  special  kind  is  constructed 
in  such  excess  as  to  make  its  surplus  marginal 
productivity  less  than  that  of  capital  in  general, 
its  salable  value  will  come  to  be  less,  while  it 
is  thus  in  excess,  than  its  cost  of  production.  But 
the  tendency  will  be  for  the  construction  of  such 
capital  to  cease  until  its  value  again  reaches  its 
cost. 

It  is  understood  that  the  labor  devoted  to  produc- 
ing consumable  goods  uses  existing  equipment 
and  that,  if  it  did  not  have  any  such  equipment 
its  marginal  product  might  be  very  much  less.  Like- 
wise the  labor  devoted  to  making  equipment  uses 
preexisting  equipment  in  so  doing.  It  is,  indeed, 
clear  that,  in  general,  industry  is  immensely  more 
productive  with  capital  than  it  could  possibly  be 
if  there  were  no  capital.  The  marginal  products  of 
the  other  factors  are  greater  the  larger  are  the 
accumulations  of  capital  of  which  these  other 
factors  can  make  advantageous  use,  while  the 
marginal    productivity    of    waiting    is    diminished 

not  decide  to  buy  the  capital  until  the  end  of  the  3'ear  he  makes 
his  decision  when  there  is  no  longer  open  to  him  the  alternative  of 
himself  producing  it  and  enjoying  its  use  equally  early-  Neverthe- 
less, the  opportunity  to  make  choices  among  all  the  options  here  sug- 
gested continually  recurs  and  is  of  importance  in  the  determination 
of  capital  value.  There  is  also  the  option,  for  A,  of  ccmbining  his 
effort  with  that  of  others  so  as  to  produce  the  capital  in  less  than  a 
year.  In  that  case  it  is  only  partly  his  but  also  he  has  only  paid  part 
of  its  cost.  The  possible  options  significant  for  the  interest  problem 
include,  of  course,  not  only  the  choice  between  direct  and  roundabout 
production  but  also,  as  suggested  above  in  this  note,  choices  between 
longer  and  shorter  roundabout  processes.  These  choices,  too,  are 
choices  between  larger  and  smaller  later  incomes  as  much  as  they 
are  choices  between  earlier  and  later  incomes. 


The  Rate  of  Interest  161 

and   the   rate   of   interest   lowered.     That    capital 
should    be    accumulated    is    important,    therefore, 
even  to  those  persons  who  cannot  themselves  save 
any.     Likewise,  in  a  community  which  has  large 
accumulations  of  capital  and  in  which,  consequently, 
the    productivity    and    price    of    other    factors    is 
high,   the   individual   business   man    cannot   afford 
not  to   use   capital.     Were   an   employer   of   labor 
to  use  no  capital  at  all  in  his  business,  the  product 
turned  out  by  his  employees  would  seldom  or  never 
pay  their  wages.    Nor  would  this  product  probably 
pay  the  rent  charged  by  the  owner  of  the  site  used. 
The  difference  between  using  and  not  using  capital 
might   therefore   be   the   difference   between    swift 
failure  and  measurable  success.     But  the  difference 
between  using  a  little  more  or  a  little  less  capital 
would  be  of  comparative  unimportance  and  might 
be  a  difference  of  only   10  or   5   per   cent  of  the 
additional  increment  used.^''    In  modern  production 
there  is  practically  always  more  than  one  factor; 
usually  there  are  three.    Whatever  may  have  been 
true  of  primitive  man,   modern   man   always  uses 
tools.     He  uses  tools  to  make  tools  and  buildings 
to   make  the  structural   material   for   more   build- 
ings.    The  point  here   to   be   emphasized   is   that, 
in  the  case  of  a  man  who  is  marginal  between  the 
two  employments,  what  his  labor  can  add  to  the 
equipment    of    society    which    existing    equipment 
cooperating  with  other  labor  would  produce  without 
him,  will  exchange  for  what  his  labor  could   add 
to  the  consumable  goods  or  services  available  to 

39  Cf.  Jevons,   The  Theory  of  Political  Economj-,  fourth   edition, 
London   (Macmillan),   1911,  pp.  256-259. 


162        Earned  and  Unearned  Incomes 

society,  which  existing  equipment  cooperating  with 
other  labor  would  produce  without  him.  Since  goods 
are  produced  by  land,  labor  and  capital  acting  in 
conjunction,  and  since  this  is  as  true  in  the 
production  of  more  capital  as  in  the  production 
of  consumable  goods,  we  must  broaden  our  state- 
ment if  it  is  to  make  proper  reference  to  land 
and  capital  as  factors  in  the  production  of  addition- 
al capital.  Let  us  say,  then,  that  the  value  of 
any  capital  will  be  equal  to  the  amount  of  con- 
sumable goods  which  the  labor  and  the  land  and 
the  capital  used  in  producing  the  additional  capital 
in  question  could  produce, *''  assuming  each  of 
these  factors  to  be  used  in  its  most  profitable 
alternative  way.  And  the  fact  that  capital  of  a 
certain  value  determined  as  has  been  herein  set 
forth  will  yield  a  given  income,  is  a  reason  why 
interest  on  loans  is  a  given  per  cent. 

In  the  third  place,  attention  should  be  called  to 
the  fact  that,  in  a  modem  community,  to  a 
considerable  percentage  of  business  men,  invest- 
ment and,  therefore,  capitalistic  or  roundabout 
production  does  not  involve  primarily  manufactur- 
ing but  has  to  do  rather  with  merchandising. 
Hence  roundabout  production  may,  for  them,  in- 
volve other  investment  outlays  in  addition  to  those 
for  the  provision  of  such  material  equipment  as 
stores,  delivery  trucks,  etc.  These  other  outlays 
of  the  merchant — and  of  the  manufacturer  in  so 
far  as  he  must  devote  a  part  of  his  attention  to 
the    mere    selling    of    his    goods    at    a    profit,    as 

■•o  The  labor,  land  and  capital  here  considered  are  assumed  to  be, 
each,  not  specialized  but  marginal  between  two  uses. 


The  Rate  of  Interest  163 

distinguished  from  the  manufacture  of  them — 
include,  for  example,  outlays  for  the  building  up 
of  goodwill,  among  which  advertising  is  perhaps 
the  most  important.  Competitive  advertising  may, 
indeed,  be  a  waste  of  a  community's  labor  time. 
The  argument  currently  advanced  that  it  enables 
a  merchant  or  manufacturer  to  sell  more  cheaply 
because  of  the  increased  volume  of  his  business 
may  be  applicable  in  the  case  of  any  one  merchant 
or  manufacturer  who  advertises,  as  contrasted  with 
the  prices  he  would  have  to  charge  if  he  did  not 
advertise.  But  when  the  advertising  is  done  by 
all  sellers  in  any  line  the  result  may  well  be  that, 
on  the  average,  their  business  is  no  larger  while 
the  expense  of  doing  it  is  greater,  so  that  the 
charges  for  the  goods  sold  must  be  higher.  Even 
if  each  of  the  sellers  of  these  goods,  by  virtue  of 
advertising,  sells  more  than  before,  the  increased 
purchases  by  the  public  in  this  line,  thus  stimulated 
by  advertising,  inevitably  mean  less  purchased 
in  other  lines.  It  is  difficult  to  see,  therefore, 
how  competitive  advertising,  except  so  far  as  it 
may  be  a  necessary  means  of  developing  intelligent 
discrimination  among  purchasers  and  so  some- 
what stimulating  rivalry  among  producers,  can  be 
anything  but  wasted  effort.  The  time  may  come 
when,  for  its  own  protection  against  increasing 
costs  of  distributing  products,  the  public  will 
establish  and  enforce  a  maximum  limit  to  advertis- 
ing, will  fix,  as  it  were,  a  plane  of  competition  in 
advertising,  just  as  it  endeavors  to  fix  a  plane  of 
competition  as  regards  employment  of  child  labor, 
price  discrimination,  railroad  rebates,  etc.  How- 
ever  this   may   be,   advertising   is   an    investment 


164        Earned  and  Unearned  Incomes 

which,  for  the  individual  concern  which  engages 
in  it,  is  often  well  worth  while.  For  such  a 
concern  it  is  productive.  And  for  such  a  concern 
the  building  up  of  goodwill  in  this  way,  from 
which  profitable  results  are  expected  in  the 
future  rather  than  at  once,  is  clearly  a  case  of 
roundabout  production.  It  might  well  be  financially 
advantageous  to  borrow  the  funds  for  the  purpose 
and  pay  interest  on  them.  The  labor  and  other 
factors  employed  in  advertising  are  employed 
analogously  to  the  labor  and  other  factors  used 
in  constructing  material  equipment.  The  purpose 
is,  not  to  change  the  form  of  wood,  iron,  etc., 
as  in  the  latter  type  of  operation,  but  to  change 
the  mental  processes  of  potential  purchasers  of 
certain  goods.  The  labor  devoted  to  doing  this 
does  not  directly  and  immediately  produce  its 
own  food  and  clothing  or,  even,  the  sales  which 
bring  money  income  (exchangeable  for  food  and 
clothing)  to  the  employing  firm.  To  keep  this  labor 
thus  employed  in  a  roundabout  process  which 
yields  a  greater  but  a  less  early  return  than 
direct  activity  would  yield,  current  means  of 
livelihood  must  be  provided  to  those  so  employed. 
The  persons  who  furnish  newspaper  plant  and 
other  equipment  for  the  purpose  must  also  receive 
payment  in  the  form  of  purchasing  power  ex- 
changeable for  a  certain  amount  of  subsistence.*^ 

*i  In  this  connection  it  may  be  well  to  point  out  that  the  expendi- 
tures of  a  government  for  war  purposes  are,  in  a  sense,  expenditures 
for  roundabout  production.  The  army  of  a  dynastic  or  imperialistic 
state  is  maintained  as  a  means  to  the  realization  of  dynastic  or 
imperialistic  aims.  A  democratic  nation  may  wage  war  for  the 
perpetuation   of    democratic    institutions.      In    either   case,    the    food, 


The  Rate  of  Interest  165 

As  always,  of  course,  when  wages  and  other 
payments  are  made  in  money,  the  persons  receiv- 
ing these  payments  may,  if  they  choose,  spend  the 
sums  received  for  capital.  But  if  they  do  they 
are  receiving  future  goods  for  future  rather  than 
present  goods  for  future  and  the  rate  at  which 
present  goods  exchange  for  future  has  in  the 
circumstances,  no  particular  significance.  In  pass- 
ing, mention  may  be  made  of  the  fact  that  sub- 
sistence, etc.,  used  to  make  possible  leisure  from 
direct  production  and  the  devoting  of  time  to 
securing  general  education  or  technical  training 
may  be  said,  often,  with  truth,  to  be  used  for 
roundabout  production. 

§  10 

Interest  Earned  and  Unearned 

Roundabout  production  may  and  often  does 
involve  exploitation.  Thus,  a  manufacturing  con- 
cern the  dividends  of  which  will  be  enhanced  if  it 
can,  in  future,  be  assured  of  freedom  from  com- 

clothing  and  munitions  furnished  the  soldiers  make  it  possible  for 
them  to  devote  themselves  to  ends  more  or  less  remote  but,  in  the 
view  of  their  government,  ultimately  desirable  ends,  as  distinct 
from  devoting  themselves  to  the  immediate  production  of  consuma- 
ble goods.  But,  of  course,  the  providing  of  millions  of  soldiers 
with  goods  which  are  immediately  consumed  and  destroyed  makes 
it  impossible  to  provide  so  many  producers  with  the  means  requisite 
to  carry  on  roundabout  industrial  processes,  tends  to  raise  the 
surplus  marginal  product  of  roundabout  production  and  tends 
towards  higher  interest  rates.  Means  of  defense  are  necessary  and 
clearly  justifiable  for  a  nation  surrounded  by  armed  potential  foes; 
yet  it  is  also  clear  that  from  the  point  of  view  of  toorld  economy, 
competitive  military  and  naval  establishments  are  not  instruments  of 
production  but   merely  very   heavy   burdens. 


166        Earned  and  Unearned  Incomes 

petition  with  foreign  rivals,  will  be,  from  the 
point  of  view  of  its  stockholders,  engaged  in 
roundabout  production  when  it  pays  for  advertis- 
ing space  in  newspapers  to  create  a  general  senti- 
ment in  favor  of  the  tariff  as  a  wage-raising 
device,  contributes  openly  or  by  indirection  to  a 
political  campaign  fund,  and  hires  lobbyists  to 
care  for  the  particular  schedules  in  which  it  is 
interested.  All  of  the  labor  and  other  factors  so 
employed  must  be  paid  what  the  market  condi- 
tions require  and  therefore  must  be  paid  not  less 
than  they  could  secure  in  direct  production.  The 
activities  of  these  factors  are  expected  to  yield 
larger  eventual  returns  to  the  employing  company 
than  if  they  were  used  in  selling  or  in  producing 
immediately  salable  goods.  Did  the  company 
borrow  to  carry  out  such  a  policy,  the  borrowing 
clearly  would  not  be  the  result  of  a  desire  upon 
the  part  of  the  company's  stockholders  to  secure 
present  consumable  goods  for  their  own  con- 
sumption but  because  the  control  of  present 
consumable  goods  (or  the  funds  to  purchase 
them)  enables  the  company  to  employ  in  a 
relatively  long-time  process  labor  and  other  factors 
which  might  else  have  been  employed  in  more  direct 
production,*-  and  to  reap  a  gain  in  so  doing.  The 
company's  demand  for  funds  has  resulted,  not 
from  preference  for  present  goods  over  future 
but  from  preference  for  a  larger  future  income  over 
a  smaller  future  income.  Clearly,  the  gain  from 
roundabout  production   is  not  necessarily  a   social 

*2  Or  in  roundabout  production  for  some  other  employing  company, 
thus  displacing  another  set  of  employees  and  equipment  for  more 
direct   production. 


The  Rate  of  Interest  167 

gain.  Exploitation  of  the  masses  by  a  plutocracy 
may  be,  in  part,  exploitation  by  a  roundabout 
process.  Income  so  secured  is  not  earned  by 
service  rendered,  although,  of  course,  the  owners 
of  the  funds  used  receive  their  interest  return  for 
rendering  a  service  to  those  who  are  rendering  the 
public  a  disservice.  Income  derived  from  the  use 
in  serving  the  public,  of  funds  accumulated  by  the 
saving  of  gains  themselves  legitimats,  is  earned. 
Income  secured  by  injuring  or  assisting  in  injuring 
the  public  should  be  terminated  so  far  as  is 
reasonably  possible,  by  effectively  prohibiting 
exploitive  activities. 

It  should  now  be  clear  that,  if  all  possible 
anti-social  uses  of  capital  were  effectively  for- 
bidden, interest  on  capital  would  be  earned  as 
truly  as,  under  like  circumstances,  the  wages  of 
labor  would  be  earned.  The  person  who  had 
accumulated  capital,  who  had,  by  his  saving, 
brought  into  existence  capital  which,  except  for 
him,  would  never  have  come  into  existence,  and 
who  thereby  had  made  possible  an  addition  to  the 
current  product  of  industry,  would  have  earned, 
in  the  sense  of  giving  a  quid  pro  quo,  interest  on 
this  capital.  Such  interest,  contrary  to  the  view 
of  Marxian  socialists  who  include  all  interest  in 
what  they  call  "surplus  value"  is  in  no  sense 
exploitation.  There  is,  indeed,  far  too  much 
exploitation  in  the  modern  industrial  world.  The 
nature  of  some  of  this  exploitation  has  already 
been  explained  in  this  and  the  previous  chapter 
and  attention  will,  as  we  proceed,  be  devoted  to 
exploitation  of  other  kinds.  But  that  interest, 
purely  as  such,  is  necessarily  exploitation,  is  a  claim 


168        Earned  and  Unearned  Incomes 

which  neither  the  socialists  nor  anyone  else  can 
substantiate.*^ 

§11 

Summary 

The  interest  rate  in  a  modern  community  is  a 
result  of  the  influence  of  many  alternatives  of 
many  individuals.  A  person  may  lend  or  borrow, 
he  may  buy  capital  with  consumable  goods  or 
sell  capital  for  consumable  goods,  he  may  engage 
in  relatively  roundabout  or  relatively  direct  pro- 
duction. The  rate  at  which  present  goods  ex- 
change for  future  goods  outside  of  loan  contracts, 
is    a    part   of   the   same    problem.      The   value    of 

*3  Nor  do  owners  of  capital  as  such,  have  any  advantage  over  the 
rest  of  the  community  in  the  ability  to  profit  beyond  their  own  con- 
tributions by  the  accumulated  technological  knowledge  of  the  race. 
(That  they  do  have  this  advantage  seems  to  be  asserted  by  Professor 
Thorstein  Veblen  in  The  Instinct  of  JVorkmanship,  New  York, — 
Macmillan — ,  1914,  p.  281-)  In  this  regard,  not  they  alone  but  all 
of  us  of  the  present  generation,  reap  where  we  have  never  sown. 
Labor  or  land,  as  well  as  capital,  may  thus  be  rendered  more  produc- 
tive than  in  the  past.  But  in  truth,  //  the  capital  from  ivhich  any 
person  derives  interest  nvas  itself  fairly  earned  and  is  used  in  socially 
desirable  luays,  its  use  adds  to  the  productiveness  of  industry,  over 
and  above  what  all  the  land,  labor  and  other  capital  of  the  commun- 
ity could,  in  the  prevailing  state  of  technological  information,  have 
produced  without  it,  all  that  its  owner  receives  as  interest.  His  gain 
leaves  to  the  rest  of  the  community  all  that  the  intellectual  equip- 
ment of  the  race  could  have  produced  without  his  accumulation. 
He  reaps  only  the  additional  value  output  which  would  not  have  re- 
sulted except  for  him.  And  in  proportion  as  large  amounts  of  capi- 
tal have  been  accumulated  and  its  marginal  productivity  and  interest 
so  reduced,  the  tendency  is  for  others  than  the  owners  of  capital 
to  profit  greatly  from  industrial  progress  and  from  capital  con- 
struction. 


The  Rate  of  Interest  169 

capital  is  influenced  by  the  rate  of  impatience  or 
time  preference  at  which  its  expected  future 
benefits  are  discounted  but  also  by  the  fact  that 
the  labor,  etc.,  devoted  to  the  production  of  this 
capital  might  have  been  devoted,  instead,  to  the 
production  of  other  and  more  immediately  con- 
sumable gX)ods.  In  a  broad  sense  the  owner  and 
user  of  capital,  no  less  than  its  owner  and  lender, 
enjoys  interest.  We  may,  with  some  gain  in  clear- 
ness, regard  the  surplus  of  roundabout  over 
direct  production,  at  the  point  beyond  which 
roundabout  production  is  not  extended,  as  the 
marginal  product  of  abstinence  or  waiting,  since 
it  is  abstinence  or  waiting  that  makes  this  gain 
possible  and  since  capital  is  not  an  ultimate 
factor.  The  gain  is  less  the  farther  abstinence 
or  waiting  is  carried.  But  the  rate  of  interest 
tends  to  equal  the  per  cent  of  this  gain,  A  rate 
of  interest  higher  than  the  marginal  product  of 
waiting  must  cause  the  demand  for  waiting  by 
those  who  would  purchase  it  (offering  future 
goods  for  present)  to  be  less  than  the  supply 
offered  by  those  who  would  sell  it.  Likewise  a 
rate  of  interest  lower  than  the  marginal  product 
of  waiting  must  cause  the  demand  for  waiting  to 
be  in  excess  of  the  supply.  Only  at  a  rate  of 
interest  equalling  the  marginal  product  of  wait- 
ing can  we  expect  the  demand  for  and  the  supply 
of  waiting  to  be  equalized.  Such  a  rate  will,  of 
course,  be  higher  than  the  marginal  yield  which 
some  men  could  secure  from  their  waiting  did  the> 
insist  on  making  use  of  all  of  it  in  business 
directed  by  themselves.  These  men  will  usually 
prefer  to  be  lenders.     The  equalizing  rate  will  be 


170  Earned  and  Unearned  Incomes 

lower  than  the  marginal  product  which  other 
men  could  secure  if  they  used  their  own  waiting 
alone.  These  other  men  will  usually  be  borrowers. 
Thus,  the  waiting  done  by  men  in  excess  of  their 
own  profitable  use  may  be  made  advantageous 
both  to  themselves  and  to  others.  The  rate  of 
interest  clears  the  market  in  exchange  of  present 
for  future  goods,  equalizes  or  tends  to  equalize  the 
time-preference  or  impatience  rates  of  those  who 
have  access  to  the  market,  equalizes  or  tends  to 
equalize  the  marginal  productivity  of  waiting  for 
different  persons  who  have  occasion  to  make  use  of 
waiting  and  who  are  able,  through  the  market,  to 
buy  and  sell  it  at  approximately  equal  rates,  and, 
also,  equalizes  or  tends  to  equalize  the  marginal 
productivity  of  waiting  for  different  lines  of 
production.  Roundabout  production  need  not  in- 
volve material  equipment  but  is  exemplified  in 
advertising,  lobbying,  and  other  non-technological 
activities.  Roundabout  production  may  be  "pro- 
duction" only  in  the  sense  of  exploiting  the  public 
for  the  benefit  of  a  few,  in  which  case  the  interest 
received  can  hardly  be  regarded  as  earned  by 
equivalent  service  given.  Fluctuating  bank  reserves 
and  rising  and  falling  prices  are  likely  to  cause 
fluctuations  in  loan  interest  but  do  not  necessarily 
affect  the  real  incomes  received  by  owners  of 
capital  who  themselves  direct  its  use.  It  is  the 
real  incomes  from  capital  which,  in  the  long  run, 
tend  to  fix  the  rate  of  interest  on  loans. 


CHAPTER  V 

WAGES  AND  POPULATION 

§   1 
The  Proximate  Determination  of  Wages 

The  larger  part  of  the  incomes  of  the  majority 
of  persons,  though  not  of  those  whose  incomes 
are  the  greatest,  are  incomes  from  labor.  Some 
incomes  from  labor,  usually  those  received  for  the 
work  requiring  least  of  physical  exertion,  we 
call  salaries.  Other  incomes,  really  the  direct 
result  of  labor,  we  call  proprietors'  or  enterprisers' 
profits.  The  part  of  a  proprietor's  income  which 
is  derived  from  capital  investment  is  then  assumed 
to  be  excluded  from  consideration.  It  is  assumed 
that  a  portion  of  his  total  income  is  due  to  or 
attributable  to  his  possession  of  capital  and 
another  portion  to  his  mental  and  physical  efforts. 
He  may,  also,  receive  accidental  gains  and  suffer 
accidental  losses,  accidental  in  the  sense  that 
some  proprietors  gain  and  others  lose  when,  so 
far  as  intelligent  observers  can  see,  managerial 
ability  and  application  is  not  correspondingly  un- 
equal. For  our  purposes,  all  of  the  returns  properly 
attributable  to  labor  or  effort  may  be  lumped 
together  as  wages. 

What  we  seek  is  a  knowledge  of  the  forces  that 
fix  wages  in  any  special  line  of  work  and  with 
that,  as  a  by-product  of  our  narrower  study,  a 
knowledge  of  what  fixes  wages  in  general.  We 
shall  find  the  law  of  wages  to  be  analogous  to  the 

(171) 


172        Earned  and  Unearned  Incomes 

law  of  interest,  and  the  approach  to  an  under- 
standing of  the  law  to  be  through  similar  avenues. 
Wages,  like  interest,  are  fixed  by  demand  and 
supply,  and  whatever  more  ultimate  forces  act 
upon  them  act  through  demand  and  supply.  If,  at 
wages  of  $2  a  day  in  any  line,  more  men  are 
wanted  in  that  line  than  are  to  be  had,  the 
resultant  bidding  tends  to  raise  the  wages  until 
the  demand  is  no  longer  in  excess  of  the  supply. 
On  the  other  hand,  if,  at  wages  of  $3  a  day,  the 
supply  of  labor  of  the  sort  in  question  is  in 
excess  of  the  demand,  then  the  seeking  of  employ- 
ment by  would-be  wage  earners  in  that  sort  of 
labor  must  tend  to  lower  wages  to  a  point  where 
supply  no  longer  exceeds   demand.^ 

^  Some  interest  attaches  to  the  question  ol  whence  comes  the  ulti- 
mate demand  for  labor.  It  is  unquestionably  true  that,  consider- 
ing economic  society  as  made  up  of  groups  producing  for  each  other 
under  modern  division  of  labor,  the  demand  for  any  special  kind  of 
labor  traces  back  of  the  employer  to  the  purchasers  of  the  goods 
made,  or  in  other  words,  to  wage  earners,  etc.,  in  other  lines  who  de- 
sire this  special  kind  of  goods  and  who,  indirectly,  are  trading  for 
them  goods  which  their  labor  or  their  line  of  industry  produces. 
In  this  view  the  labor  of  some  constitutes  a  demand  for  the  labor 
of  others,  just  as  the  supply  of  some  goods  is  said  to  constitute  a 
demand  for  other  goods.  But  while  no  one  can  demand  goods 
without,  in  effect,  offering  other  goods  in  exchange  for  them,  it  is 
certainly  possible  to  demand  labor,  in  the  sense  of  being  a  buyer 
of  labor,  while  yet  not  offering  labor  in  return.  Any  capitalist  or 
landowner  can  turn  the  trick.  His  purchases  represent  a  demand 
for  labor  but  not  a  supply,  a  demand  for  one  kind  of  labor  which 
does  not  emanate  from  a  supply  of  another  kind. 

There  are,  indeed,  advantages  from  the  point  of  view  of  a  dis- 
cussion of  general  wages,  in  thinking  of  all  labor  as  offering  its 
services  to  owners  of  property  and  owners  of  property  as  buying  these 
services.  With  a  division  of  society  into  the  two  classes  of  property 
owners  and  laborers,  with  free  contract,   but  with   no  markets   and 


Wages  and  Population  173 

Let  us  devote  brief  attention  to  some  line  of 
industry  and  attempt,  for  tliat  industry,  to  see 
what  wage-determining  factors  lie  immediately 
back  of  demand  and  supply.  For  purposes  of 
illustration,  we  shall  examine  the  wage-determining 
influences  in  a  hypothetical,  small  community,  the 
only  industry  of  which  is  the  raising  of  wheat. 
In  this  community  are  five  farms  of  various 
degrees  of  fertility  and  having  various  equipment. 
We  shall  suppose  the  size  of  farms  and  the  equip- 
ment of  each  farm  to  be,  for  our  present  problem, 
a  fixed  fact.  There  is  in  the  community  a  definite 
number  of  laborers  of  equal  eflSciency.  On  either 
one  of  two  of  the  farms,  which  we  shall  call, 
respectively,   A   and   B,   3   men   can   produce   1500 

no  exchanges  of  goods,  the  property  owners  would  find  it  advanta- 
geous to  employ  the  laborers,  agreeing  to  give  the  latter  a  part  of  the 
total  product  of  industry  and  keeping  a  part  for  themselves.  It  is 
the  relation  of  the  propertied  classes  to  wage  earners  which  we  have 
or  should  have  in  mind  when  we  speak  of  wages  in  general  as 
rising  or  failing  in  relation  to  other  distributive  shares  and  when 
we  speak  of  changes  in  the  general  demand  for  labor.  It  was 
the  relation  of  wage  earners  to  capitalists  which  Mill  had  in  mind 
when  he  stated  that  demand  for  labor  comes  not  from  the  purchasers 
of  goods  but  from  the  capital  employed  in  hiring  labor,  and  that  the 
purchasers  of  goods  simply  determine  in  what  line  or  lines  labor 
shall  be  employed.  (See  Mill,  Political  Economy,  Book  I,  Chapter 
V,  §  9)-  Were  there  no  market  for  goods,  the  capitalist  em- 
ployer, instead  of  hiring  men  to  produce  goods  for  sale  and  using 
the  proceeds  to  buy  other  goods  for  himself,  while  his  employees 
likewise  used  the  wages  which  constituted  their  share  of  the  product 
to  buy  other  goods,  would  simply  liire  the  labor  to  produce  directly 
such  goods  as  he  and  they  wanted  and  pay  them  a  share  of  the 
product.  Presumably  wages  would  not  be  so  high,  under  this  ar- 
rangement, as  under  the  modern  system  of  specialization  of  capi- 
tals and  complex  division  of  labor,  since  specialization  makes  for 
greater  efficiency  of  production. 


174        Earned  and  Unearned  Incomes 

bushels,-  4  men  can  produce  1900  bushels,  5  men 
can  produce  2200  bushels,  6  men  can  produce 
2450  bushels,  7  men  can  produce  2650  bushels.  On 
each  of  the  other  three  farms,  3  men  can  produce 
1200  bushels,  4  men  can  produce  1500  bushels,  5 
men  can  produce  1750  bushels,  6  men  can  produce 
1950  bushels,  7  men  can  produce  2100  bushels. 

The  reader  will  notice  that  the  product  per  man 
is  less  as  the  number  of  men  working  on  a  given 
area  is  greater.  We  have  put  into  the  numerical 
terms  of  our  illustration  the  fact,  with  which 
every  business  man  and  every  farmer  is  familiar, 
that  after  a  certain  degree  of  utilization  is  reached 
a  larger  force  working  with  a  given  equipment 
and  in  a  given  space  or  on  a  given  area,  though 
its  total  production  may  be  greater  and  though, 
with  wages  sufficiently  low,  its  employment  may  be 
worth  while,  will  not  secure  a  product  as  large 
per  man  employed  as  the  smaller  force.  It  is  to 
be  emphasized  that  the  above-stated  law  of  pro- 
duction applies  as  certainly  to  work  in  a  factory 
or  an  office  building  as  on  a  farm.  It  is  true  that 
a  given  land  area  can  be  very  intensively  used  in 
manufacturing,  in  mercantile  business  or  in  pro- 
fessional work,  by  building  story  upon  story. 
Nevertheless,  diminishing  returns  are  realized  in 
proportion  to  the  labor  involved,  because  of  the 
progressively  stronger  foundations  necessary  with 
increasing  height,  because  of  the  increased  elevator 
expenses,  and  perhaps  other  disadvantages. 

2  It  need  not  be  supposed  that  these  two  farms  are  of  equal  fer- 
tility- One  may  have  greater  fertility  and  the  other  more  or  bet- 
ter  equipment. 


Wages  and  Population.  175 

Before  attempting  to  go  farther  in  explaining 
how  wages  would  be  determined  in  our  assumed 
community,  it  will  be  worth  while  to  call  attention 
to  the  way  in  which  an  individual  employer' 
adjusts  his  business  to  wages.  Each  employer 
determines,  in  the  light  of  current  wages  and  in 
the  light  of  the  probable  advantage  to  him  of  the 
services  to  be  rendered,  how  many  men  he  will 
hire.  In  order  to  give  greater  exactness  to  the 
statement  we  may  say  that  each  employer  hires 
men  up  to  the  point  where  the  last  man  hired  is 
expected  to  be  worth  no  more,  in  this  employer's 
business,  than  the  wages  which  the  man  must  be 
paid.*      The    individual    employer,    except    in    the 

3  Who  may  be  a  capitalist,  a  landowner,  an  enterpriser  using 
chiefly  borrowed  funds,  or  himself  a  hired  servant  of  owners  of 
property. 

*  If  wages  must  be  paid  before  the  product  is  sold  then,  obviously, 
an  employee  the  product  of  whose  labor  is  not  worth,  when  sold, 
his  wages  plus  the  interest  his  employer  has  to  pay  (or  forego  from 
some  alternative  investment  to  pay  him),  is  not  worth  hiring.  Hence, 
a  potential  employee's  service  may  be  of  much  less  value  to  an 
employer  whose  credit  is  not  good  and  who  must  pay  high  interest 
on  borrowed  funds,  than  to  an  employer  in  a  more  favorable  finan- 
cial condition.  To  the  general  theory  of  employer's  demand  for 
labor,  as  presented  in  the  text,  some  one  may  object  that  an  ex- 
ceptionally capable  employer  could  gain  more  from  the  labor,  as 
also  from  the  land  and  the  capital,  used  by  him  than  could  an 
employer  less  capable,  and  that,  therefore,  the  essential  problem 
relates  merely  to  the  proportioning  of  factors  and  not  to  the  marginal 
productivity  of  an\'  one  or  of  each  of  the  factors.  But  if  such  an 
exceptionally  efficient  employer  could  add  more  to  the  annual  product 
of  his  business,  by  hiring  more  men,  than  the  wages  to  be  paid,  and 
did  not  do  it  (and  the  same  principle  would  apply  to  his  borrowing 
of  capital  or  renting  land),  he  would  not  be  making  the  most  ef- 
fective use  of  his  directing  ability;  he  would  not  be  choosing  the 
best    proportion    of    other   factors    to   the    amount    and    quality    of    a 


176        Earned  and  Unearned  Incomes. 

cases  where  he  has  substantially  a  monopoly,  has 
no  appreciable  influence  over  the  price  of  the 
product  he  sells.  Nor  has  he,  so  far  as  the  wage 
earners  are  familiar  with  market  conditions  and 
reasonably  able  to  take  advantage  of  them,  much 
control  over  the  wages  he  has  to  pay.  Even  the 
monopolist,  as  to  product,  has  competitors  in  the 
wages  market  against  whom  he  must  bid  in  seek- 
ing labor.  In  general,  the  individual  employer  can 
react  to  wages  only  by  adjusting  his  demand  for 
labor  to  the  wages  he  must  pay. 

Consider,  now,  the  demand  for  labor,  of  one 
of  the  farm  owners  in  our  hypothetical  community. 
Assuming  wheat  to  be  $1  a  bushel''  and  wages  to  be 
$300  a  year,**  the  owner  of  farm  A  could  profitably 
use  four  men  and  could  use  five  without  loss.  His 
demand,  with  wages  at  this  level,  would  be  for 
four  or  five  men.  With  wages  less  than  $300  he 
would  want  five  men.  With  wages  more  than  $300 
he  could  afford  only  four  men.^  With  wages  at 
just  $300,  he  would  be  indifferent  whether  to  hire 
four    men    or    five.«      With    four    men    hired,    th<i 

particular  kind  of  labor  used  in  his  business,  viz.,  labor  of  manage- 
ment.      (See    Carver,    The    Distribution    of    Wealth,    New    York 

Macmillan — ,   1904,  pp.  90-94). 

^  Net  to  the  farm  owner. 

6  Payable,  we  may  now  assume,  when  the  product  is  sold.  If 
the  wage  is  payable  earlier,  a  somewhat  lower  wage  would  be 
necessary  to  bring  out  the  same  demand  for  labor. 

^  In  practice  there  are  intermediate  possibilities,  such  as  hiring 
a  fifth  man  for  part  time.  As  the  principle  of  the  solution  given 
in  the  text  is  not  changed  by  this  fact,  it  will  be  better  not  to  com- 
plicate our  illustration  with  it. 

*>  Someone  may  object  that  the  extra  bother  of  dealing  with  and 
directing  the   fifth   man   will   prove   conclusive   against   his   employ- 


Wages  and  Population.  177 

total  product  of  his  farm  would  be  1900  bushels 
or  $1900  of  value  and  his  wage  bill  $1200,  leaving 
him  $700  as  interest  on  equipment  and  rent  on 
land.  With  five  men  employed,  the  total  product 
of  his  farm  would  be  2200  bushels  or  $2200  and 
his  wage  bill  $1500,  leaving,  again,  $700  of 
interest  on  equipment  and  rent  on  land.  Since  the 
fifth  man  receives  if  hired,  as  wages,  just  what 
his  services  add  to  the  product  that  would  be 
secured  without  him,  the  employer's  net  profits 
are  equally  great  whether  this  man  is  hired 
or  not.  It  must  not  be  understood  that  the  fifth 
or  last  man  hired  is  of  less  ability  or  efficiency  than 
the  rest.  It  is  not  that  the  other  men  produce 
more  and  he  less.  What  the  illustration  means  is 
merely  that,  taking  all  five  men  to  be  of  equal 
capacity  and  energ>%  the  difference  between  having 
five  men  and  having  four  to  work  on  the  given 
farm  is  less  than  the  diff"erence  between  having 
four  and  having  three.  This  fact  is  but  an  ex- 
emplification of  the  law  of  diminishing  returns. 

Let  us  now  suppose  wages  to  be,  not  $300,  but 
$400  per  man.  In  that  case  the  employer  on 
farm  A  could  afford  to  hire  but  four  men  (he 
might  hire  only  three),  making  his  product  $1900, 

ment.  But  by  our  hypothesis  the  fifth  man  makes  the  total  product 
$300  larger  than  it  would  be  with  all  the  other  labor  necessary 
except  his.  The  $300  is,  in  short,  a  net  addition.  For  simplicity, 
we  shall  suppose  the  labor  of  management,  if  any  is  required,  to 
be  of  equal  productivity  and  to  receive  equal  renumeration  with 
the  other  labor  involved-  If,  moreover,  the  farm  owner  works  on 
his  farm,  he  counts  one  among  the  number  he  can  use  in  its  culti- 
vation, i.  e.,  he  is  one  of  the  four  men  or  one  of  the  five  men  em- 
ployed, and  himself  receives  one  man's  wages  besides  interest  and 
rent- 


178        Earned  and  Unearned  Incomes. 

his  wage  bill  $1600  and  his  interest  and  rent 
return  $300.  It  should  be  clear  from  this  illustra- 
tion that  the  individual  employer's  demand  for 
men  to  work  on  a  given  area  and  with  the  aid  of 
a  given  investment  in  equipment,  is  greater  or  less 
according  as  wages  are  less  or  greater. 

Obviously,  the  ethical  justification  of  the  work 
for  which  labor  is  hired  has  nothing  to  do  with 
the  economic  law  under  discussion,  so  long  as  men 
are  found  who  will  engage  in  any  special  business 
for  profit  and  other  men  can  be  found  to  work  for 
them  for  pay.  Thus,  a  manufacturers'  association 
seeking  tariflF  favors  at  the  expense  of  the  public, 
would  be  likely  to  employ  a  larger  body  of 
lobbyists,  and  to  hire  more  editors  and  popular 
writers  for  the  purpose  of  influencing  public  opin- 
ion and  getting  what  they  desired,  if  these  ser- 
vices could  be  secured  for  lower  pay  than  if 
they  must  be  got  by  the  offer  of  higher  pay.  In 
such  work  it  may  be  difficult  to  tell  at  what  point 
additional  workers  are  just  worth  the  wages  paid 
and  beyond  what  point  further  employment  of  skill 
is  not  worth  while.  Yet  it  is  not  to  be  doubted 
that  the  principle  involved  is  the  same."  So,  also, 
the  manufacturer  of  a  noxious  drug  no  less  than  the 
manufacturer  of  a  breakfast  food,  will  hire  men  to' 
work   in   a  given   factory,   up  to   the  point  where 

"The  analogy  with  the  previous  illustration  is  closest  when  we 
suppose  that  additional  writers  or  lobbyists  would  make  less  and  less 
diflference  with  the  schedules.  But  if  the  choice  were  between  get- 
ting the  desired  tariff  favors  or  none  at  all  and  if  only  a  trifle  more 
influence  was  thouglit  necessary  to  get  these  favors,  tlien  the  desire 
for  such  additional  influence  might  be  very  great  whereas  further 
influence  beyond  this  might  have  no  utility  whatever. 


Wages  and  Population.  179 

further  labor,   in  that  factory,   is  worth   no  more 
than  the  wages  which   must  be  paid. 

We  are  now  ready  to  take  up  the  direct  ex- 
planation of  how  wages  are  determined  in  our 
hypothetical  community.  We  shall  suppose  the 
number  of  men  available  for  employment  on  the 
five  farms  to  be  twenty-one.  We  shall  arrive  at 
the  rate  of  wages  in  the  community  by  assuming 
various  rates  and  seeing  how  each  would  affect 
demand  and  supply  of  labor.  Suppose,  first,  that 
wages  are  $400  a  year  per  man.  Then  not  more 
than  four  men  apiece  can  be  employed  on  farms 
A  and  B  since  a  fifth  man  increases  the  product  by 
only  $300.  Nor  can  more  than  three  men  be 
employed  without  loss  on  any  of  the  other  three 
farms.  Hence,  at  wages  of  $400  per  man,  not 
more  than  seventeen  men  could  get  employment. 
At  wages  of  $400  per  man,  the  supply  of  labor 
is  very  decidedly  in  excess  of  demand.  Rather 
than  remain  idle,  most  or  all  of  these  men  would 
work  for  less  than  $400.  The  competitive  situa- 
tion   practically    compels    lower    wages    than    this. 

On  the  other  hand,  wages  of  $250  also  fail  to 
satisfy  the  condition  of  equilibrium.  Wages  so 
low  as  this  would  make  it  possible  for  the  owners 
of  A  and  of  B  to  employ,  each,  five  or  six  men, 
while  C,  D  and  E  farms  could  use  four  or  five 
apiece.  There  would  be  very  considerable  advan- 
tage in  the  employment  of  not  less  than  five  by  A 
and  by  B  and  not  less  than  four  each  by  C,  D  and 
E.      Hence,   there   would   be   active   bidding'''   for 

!'>  In    the    absence   of   collusion,    which    \vouId    exists    tiie    less    the 
larger  was  the  community  and  the  greater  the  number  of  employers. 


180        Earned  and  Unearned  Incomes. 

twenty-two  men  and  a  willingness  to  hire,  perhaps, 
twenty-seven.  But,  according  to  our  assumptions, 
only  twenty-one  men  are  available.  Therefore  the 
demand  for  labor  exceeds  the  supply  and  the  bid- 
ding of  employers  must  go  on  up  to  wages  above 
which  there  is  no  further  advantage  to  any  em- 
ployer in  seeking  to  get  labor  away  from  others. 
It  will  readily  be  seen  that  wages  of  about  $300 
per  man  fulfill  this  condition.  At  wages  of  $300 
or  not  much  less,  it  would  be  possible,  indeed,  to 
get  twenty-two  men  employed,  five  each  on  A  and 
B  and  four  each  on  C,  D  and  E.  But  this  does 
not  mean  that  at  $300  demand  exceeds  supply  by 
one,  for  none  of  the  five  employers  would  bid 
over  $300  to  get  any  of  these  men  away  from  any 
other.  Thus,  with  wages  at  about  $300,  five  men 
might  be  employed  on  farm  A,  five  on  B,  four  on 
C,  four  on  D  and  three  on  E.  This  would  mean 
that  all  twenty-one  men  were  employed,  yet  the 
owner  of  farm  E  would  not  offer  any  higher  wages 
in  order  to  employ  a  fourth  man  but  would  be 
indifferent  in  the  matter.  Hence  demand  would  not 
be  in  excess  of  supply."  And  the  wages  which 
equalize  demand  for  and  supply  of  labor,  which 
clear  the  market,  are  wages  measured  by  labor's 
marginal  contribution  when  all  are  employed.  No 
one  of  the  wage  earners  will  receive  more  than  his 
labor  adds  to  the  product  which  would  be  secured 
without  his  participation  in  the  productive  process. 
Of  course  it  follows  that  in  case  the  workers  are 

^1  In  practice  there  would  be  the  possibility  of  four  men  dividing 
their  time  among  five  farms.  The  mathematical  economist  will 
know   how   to  develop   refinements  of  this  sort. 


Wages  and  Population.  181 

of  unequal  efficiency,  instead  of  being,  as  above 
assumed,  of  equal  efficiency,  their  wages  will  be 
unequal,  each  being  paid  according  to  his  output. 

Wages  being  thus  determined,  the  remaining 
product  on  each  farm,  aside  from  the  amount  neces- 
sary to  maintain  fertility  and  equipment  in  its 
original  condition,  goes  to  interest  on  capital  and 
rent  on  land.  Let  us  suppose  that  the  2200 
bushels  or  $2200  produced  on  farm  A  is  net 
product,  1.  e.,  is  all  in  excess  of  necessary  repair 
and  depreciation  charges.  Then,  since  the  wages 
of  five  men  at  $300  each,  aggregate  $1500,  there 
is  left  $700  as  interest  and  rent.  We  have  already, 
in  a  previous  chapter,^-  seen  how  interest  is 
determined.  If  we  suppose  return  on  accumulated 
capital  to  be  at  the  rate  of  8  per  cent  and  the 
investment  in  improvements  and  equipment  on 
farm  A  to  be  $5,000,  then  $400  of  the  product  can 
be  attributed  to  invested  capital,  leaving  $300  as 
rent  of  the  unimproved  land.  Capitalizing  this 
rent  on  an  8  per  cent,  basis,  we  arrive  at  a  value 
for  the  land  exclusive  of  improvements,  of  $3,750. 

Each  wage  earner  gets,  as  wages,  in  a  fair 
competitive  market,  what  his  labor  adds  to  the 
product  that  would  have  been  secured  without 
him.  And  each  accumulator  of  capital  gets,  as 
interest  on  that  capital,  what  his  accumulation 
thus  adds  to  the  product  that  would  have  been 
secured  without  the  aid  of  his  capital.  But  if, 
through  the  spread  of  habits  of  saving,  the  volume 
of  capital  increases  while  the  number  of  wage 
earners  does  not,  each  wage  earner's  efforts  will 

12  Chapter   IV. 


182        Earned  and  Unearned  Incomes. 

add  more  than  previously  to  the  product  that 
would  have  been  secured  v^ithout  those  efforts  and 
hence  wages  will  be  higher,"  while,  on  the  other 
hand,  the  marginal  product  of  capital  will  be 
reduced  and  hence  the  rate  of  interest  will  be 
lower.  It  is  desirable,  therefore,  even  in  the 
interest  of  those  who  themselves  save  no  capital, 
that  capital  should  be  saved. 

It  should  be  added  that  proprietors'  profits,  the 
reward  of  self-employed  managerial  effort,  are 
subject  to  the  same  law  as  other  wages,  i.  e.  they 
depend  on  the  value  productivity  of  the  work  done. 
If  managerial  ability  of  the  highest  order  is  scarce, 
its  marginal  product  is  large  and  profits  will  be 
large.  If  it  is  plentiful,  its  marginal  product  is 
less  and  competition  must  tend  to  lower  profits. 
Managerial  ability  is  sometimes,  however,  devoted 
to  achieving  success  by  price  discrimination,  by 
spreading  false  and  malicious  reports  regarding 
rival  goods,  by  making  arrangements  with  rail- 
roads (rate  discrimination)  or  with  tradesmen 
which  operate  to  exclude  competitors'  goods  from 
the  market,  or  by  conspiring  with  competitors  to 
form  a  monopoly  and  raise  prices.  Clearly,  profits 
thus  secured  are  related  to  the  value  of  the  services 
given  to  the  public,  only  in  the  sense  that  the 
services  given  have  a  high  value  because  the 
exclusion  of  competition  forces  the  public  to  pay 

^■^  Though  the  case  is  perhaps  theoretically  conceivable  in  which 
the  increased  capital  would  take  such  forms  as  to  increase  greatly 
the  demand  for  land  and  increase  rents  but  not  wages.  However, 
should  the  conclusions  of  the  next  chapter  be  accepted  and  applied, 
increase  of  capital  would  even  in  this  extreme  case  be  advantage- 
ous to  wage  earners- 


Wages  and  Population.  183 

high  prices  for  them.  The  profits  realized  are 
gained  by  doing  the  public  an  injury^*  and  the 
methods  followed  should  be  effectively  prohibited. 
There  is  no  intention,  of  course,  to  deny  the 
possibility  that  employees  as  well  as  employers 
may  receive  remuneration  for,  or  remuneration 
which  is  enhanced  by,  anti-social  activities. 


Influence  of  Physical  and  Influence  of 
Value  Productivity  on   Wages 

Enough  has  been  said  to  make  it  clear  that  wages 
in  any  given  line  are  measured  by  the  marginal  value 
productivity  of  labor  in  that  line.  Though  the 
marginal  physical  productivity  of  labor  remained 
at  300  bushels  per  year  in  agriculture,  agricultural 
wages  would  nevertheless  fall  if  the  price  of  wheat 
per  bushel  and  the  purchasing  power  of  wheat 
over  other  goods  should  fall.  If,  therefore,  an  in- 
creased per  cent  of  the  productive  labor  of  the 
world  should  go  into  the  raising  of  wheat,  we  should 
expect  the  remuneration  of  labor  so  engaged  to  fall, 
even  though  available  land  for  the  purpose  was  so 
unlimited  and  so  equal  in  goodness  that  the  num- 
ber of  bushels  produced  per  man  occupied  in 
wheat  raising  remained  the  same. 

If,  in  a  country  which  is  fairly  well  populated 
and  which  has  reached,  therefore,  as  to  its  ag- 
riculture, the  point  of  diminishing  returns,  an 
increased  number  of  persons  in  agriculture  must 

i*  Cf.  the  author's  Principles  of  Commerce,  New  York    (Macmil- 
lan)    1916,   Part  III,  Chapter  VII,   §4. 


184        Earned  and  Unearned  Incomes. 

bring  a  diminished  proportionate  physical  prod- 
uct, this  may  not  be  equally  true  of  all  or, 
possibly,  of  any  lines  of  manufacturing.  England, 
for  example,  which,  presumably,  long  since  reached 
and  passed  the  point  of  diminishing  returns  in  all 
kinds  of  agriculture  may  still,  with  regard  to  much 
of  its  manufacturing,  be  in  such  a  situation  that 
more  labor  devoted  to  such  manufacturing  would 
yield  a  physical  return  in  direct  proportion  or  in 
nearly  direct  proportion  to  the  increased  labor  so 
applied.  Nevertheless,  a  sufficient  increase  in  the 
number  of  persons  engaged  in  these  various  lines 
of  manufacturing  might  so  decrease  the  marginal 
value  product  of  their  labor  as  to  necessitate  low 
wages.  The  increased  supply  of  the  goods  thus 
produced  would  tend  to  lower  the  prices  of  these 
goods  and  hence  to  lower  the  returns  which  those 
engaged  in  producing  the  goods  could  hope  to 
receive.  We  may  conclude,  therefore,  that  the 
reduction  of  per  capita  returns  with  increase  of 
population  in  agriculture,  tends  towards  lower 
wages  even  in  manufacturing  since,  if  it  did  not, 
an  influx  of  persons  into  manufacturing  would 
occur,  lowering  relatively  the  prices  of  manufac- 
tured goods  and  raising,  relatively,  the  prices  of 
agricultural    products. 

We  must  not  conclude,  however,  that  the  returns 
to  labor  are  necessarily  as  low  (or  as  high)  in 
a  manufacturing  as  in  an  agricultural  country. 
Labor  does  not  flow  freely  from  one  country  to 
another.  Furthermore,  the  people  of  the  manufac- 
turing country  may  be  highly  efficient  and  they 
may  be  few  in  proportion  to  the  demand  for  the 
goods  they  produce;   while  relative   incapacity  or 


Wages  and  Population.  185 

lack  of  resources  for  manufacturing  may  keep  the 
people  of  the  agricultural  country  from  providing 
themselves  or  third  and  fourth  countries  with  manu- 
factured   goods. 

§  3 
Comparative    Wages    in    Different    Labor    Groups 

Something  should  be  said  regarding  the  relation 
of  wages  in  one  labor  stratum  to  wages  in  another, 
e.  g.,  the  wages  of  skilled  as  compared  with  the 
wages  of  unskilled  labor.  It  will,  of  course,  be  true 
that  both  the  skilled  and  the  unskilled  workmen's 
wages  will  be  fixed  by  the  respective  marginal 
value  products  of  their  labor.  But  the  value  of 
the  goods  produced  by  the  skilled  labor  is  relatively 
high  just  because  such  labor  is  relatively  scarce.  The 
higher  wages  of  skilled  labor  or  of  intellectual 
labor  requiring  considerable  training  are  really 
due,  then,  to  the  relatively  limited  amount  of  such 
labor    available. 

The  chief  reason  for  the  comparatively  large 
amount  of  unskilled  and  the  comparatively  limited 
amount  of  skilled  or  highly  trained  labor  (in  rela- 
tion to  the  demand  for  it)  is  the  cost  of  train- 
ing.^^  Unless  the  larger  wages  to  be  secured  by 
training  make  up,  in  the  average  life  time,  the 
cost  of  this  training  plus  interest,  entrance  into  the 
skilled  work  will  seem  to  many  or  to  most,  not 
worth  while.     Frequently  the  present  deprivation 

^5  Limitation  of  apprentices  enforced  by  an  interested  labor  group 
against  would-be  future  competitors  may  also  be  an  influence  not 
without  significance  but,  probably,  of  much  less  importance  than 
the  cause  discussed  in  (lie  text. 


186        Earned  and  Unearned  Incomes. 

which  must  be  suffered  to  meet  the  cost  of  training 
seems  much  greater  than  can  be  compensated  by 
the  larger  later  earnings  to  be  so  gained.  To  many, 
indeed,  the  cost  of  training  is  practically  pro- 
hibitive.^'^ They  simply  cannot  make  the  invest- 
ment. Could  funds  be  borrowed  for  this  purpose 
at  the  current  rate  of  interest  charged  on  well- 
secured  loans,  the  investment  might  pay  much 
better  than  investments  of  other  kinds.  But  the 
possibility  that  the  borrower  will  become  sick,  or 
will  die  (though  life  insurance  sometimes  provides 
for  this  second  contingency),  or  will  simply  fail 
to  "make  good,"  makes  the  security  uncertain  and 
the  funds  hard  to  get.  In  these  days  of  compulsory 
education  up  to  14  or  16  years  of  age,  of  night 
schools  and  of  correspondence  schools,  possibilities 
exist  for  many  who  refuse  to  take  advantage  of 
them.  But  the  opportunities  of  the  poor  boy  are 
hardly  roseate.  To  work  daytimes  and  study 
nights  is  much  harder  than  to  be  supported  by 
high-salaried  fathers  whilst  securing  the  training 
for  a  life  work.  For  some,  despite  ambition,  the 
physical  strain  is  prohibitive.  For  all  in  such 
circumstances,  the  securing  of  the  preparation 
essential  to  the  higher  grade  of  work  means  years 
of  deprivation  of  rest  or  pleasure  or  both. 

The  possibilities,  however,  are  considerable  for 
young  men  who  are  willing  to  defer  marriage  and 
the  rearing  of  a  family  until  after  thirty.  Indeed, 
marriage  is  not  incompatible  with  self-accomplished 
success    if   children    can    be    foregone    until    some 

'"  Cf.    Cairnes,    Some    Leading  Principles    of   Polilkal   Economy, 
New  '^'ork   (Harper),   1874,  pp.  65-68. 


Wages  and  Population.  187 

degree  of  preparation  for  more  skillful  work  has 
been  achieved.  For  both  man  and  wife  can  then 
be  remuneratively  employed  a  part  of  the  time 
and  can  make  enough  to  pay  for  the  leisure  and 
expense  necessary  to  train  one  or  both  the  rest  of 
the  time.  But  to  forego  for  so  many  years  the 
satisfaction  of  one  of  the  strongest  animal  instincts 
is,  for  most,  too  great  a  sacrifice.  Unless  the  in- 
stinct can  be  satisfied  and  yet  reproduction  pre- 
vented, the  opportunities  of  movement  upward  in 
the  ranks  of  labor  are  likely  to  be  much  less 
availed  of  than  might  otherwise  be  the  case.  For 
various  metaphysical,  textual  or  conventional  rea- 
sons, large  masses  of  people  believe  the  satisfaction 
of  the  sex  instinct,  when  means  are  used  to  prevent 
conception,  to  be  wrong.  Obviously  the  utilitarian 
cannot  jump  to  this  conclusion.  If  consistent,  he 
must  test  such  means  or  practices  by  their  effect  on 
aggregate  human  happiness.  He  is  bound  to  re- 
gard as  desirable  and  as  moral  a  policy  or  practice 
the  tendency  of  which  is  to  increase  this  happiness. 
The  questions  he  would  naturally  ask  regarding 
birth  control  are,  first,  whether  it  is  desirable  that 
the  number  of  births  in  general  or  in  certain  class- 
es or  in  certain  families  should  be  limited,  second, 
if  such  limitation  is  desirable,  whether  the  potential 
parents  are  happier  in  satisfying  the  sex  instinct 
and  preventing  conception  by  artificial  means  than 
they  would  be  to  deny  themselves  such  satisfaction, 
and  third,  whether  artificial  prevention  of  concep- 
tion is  necessarily  injurious  and,  if  so,  whether  it 
is  injurious  to  such  a  degree  as  to  offset  the  in- 
dividual and  social  advantages  resulting  from  it. 
If  it  is  answered  that  restriction  of  births  is  often 


188        Earned  and  Unearned  Incomes. 

desirable,  that  the  exercise  of  the  sex  instinct  under 
such  circumstances  is  a  means  of  happiness  and 
that  the  restrictive  means  may  be  so  chosen  as  to 
have  no  injurious  physiological  effects  of  cor- 
responding consequence,  or,  perhaps,  no  injurious 
physiological  effects  at  all,  can  the  thoroughgoing 
utilitarian  do  otherwise  than  approve  birth  control? 
To  the  contention  that  general  knowledge  of  the 
possibilities  of  birth  control  might  result  in  an 
increase  of  promiscuous  sex  relations  it  may  be 
replied  that  the  earlier  marriages  thus  made  pos- 
sible for  persons  who  can  not  afford  to  risk  having 
large  families  early  in  life,  would  greatly  diminish, 
for  many,  the  temptation  to  promiscuity.  It  is 
not  promiscuous  sex  relations,  but  marriage,  that 
usually  brings  to  the  male  the  responsibility  of 
supporting  children.  It  would  seem  reasonably 
certain,  therefore,  that  for  him  ability  to  postpone 
the  having  of  children  until  easy  circumstances 
make  them  desired  would  tell  in  favor  of  matrimony 
and  against  promiscuity.  But  the  opponents  of 
birth  control  may  believe,  not  only  that  there 
are  other  objections  to  promiscuity  than  the  likeli- 
hood of  children  being  born  for  whom  no  fathers 
can  be  made  responsible,  but  also  that  these  other 
objections  are  not  of  a  sort  to  impress  very  much 
other  persons  than  themselves.  The  opponents  of 
birth  control,  in  their  superior  wisdom,  see  these 
objections,  but  the  masses  of  humanity,  not  being 
competent  to  manage  their  own  affairs  except  when 
kept  ignorant,  by  force  of  law,  of  some  lines  of 
action  they  might  else  desire  to  follow,  cannot  see 
these  other  objections  and  so  might  take  up 
promiscuity.     If  indeed  there  are  no  reasons  for 


Wages  and  Population.  189 

objecting  to  promiscuity  other  than  the  danger  that 
some  children  will  have  no  definitely  ascertainable 
fathers  and  if  birth  control  removes  this  danger, 
then  promiscuity  must  cease  to  be  objectionable. 
But  if  there  are  other  important  objections  to 
promiscuity  it  is  entirely  conceivable  that  the 
advocates  of  birth  control  and  the  masses  generally 
are  as  capable  of  understanding  them  and  being 
influenced  by  them  as  those  to  whom  birth  control 
is  anathema. 

In  another  aspect  than  the  one  already  discussed 
does  the  matter  of  birth  control  touch  the  compar- 
ative welfare  of  different  economic  classes.  Pros- 
perous parents  who  can  afford  to  give  and  do  give 
their  children  the  training  necessary  as  prepara- 
tion for  the  more  remunerative  kinds  of  work 
have  relatively  few  children;  while  the  poorer  class 
of  parents  whose  children  can  have  little  training 
have  relatively  large  families.  Not  only  would 
birth  control  among  unskilled  and  slightly  skilled 
wage  earners  enable  them  as  individuals  to  fit 
their  children  for  better  jobs  than  their  own;  but 
also,  even  if  they  did  not  so  educate  their  children 
it  would  tend  to  raise  the  wages  of  these  children 
when  they  arrived  at  maturity  since  it  would 
lessen  the  number  of  unskilled  and  slightly  skilled 
wage  earners.  The  knowledge  required  for  birth 
control,  although  law  prohibits  its  dissemination  in 
the  United  States  so  that  it  is  not  easily  available 
for  the  masses,  is  familiar  to  many  if  not  most 
persons  among  the  professional  classes.  They  can 
and  do  regulate  the  number  of  children  they  shall 
have.  It  may  be  added  that  they  do  so  in  full 
consciousness  of  the  fact  that  under  present  condi- 


190        Earned  and  Unearned  Incomes 

tions  there  is  a  great  gulf  between  professional 
earnings  and  the  earnings  of  ordinary  labor.  They 
endeavor  not  to  have  more  children  than  they  can 
afford  to  educate  for  the  professions  or  the  higher 
positions  in  business.  Were  the  birth  rate  among 
unskilled  and  slightly  skilled  wage  earners  lower, 
the  number  of  children  they  could  put  into  the 
higher  grades  of  labor  greater  and,  in  any  case, 
the  number  of  children  who  must  at  maturity  or 
sooner  go  into  the  lower  grades  of  labor  smaller, 
were  the  differences  in  wages  of  so-called  high 
grade  and  so-called  low  grade  labor  thus  reduced 
to  a  minimum,  then  it  would  nn*^,  nsr'i.-io?.  po'iom 
so  unfair  as  now,  to  parents  of  the  professional  and 
business  enterpriser  class,  to  have  more  children 
than  they  could  afford  to  educate  for  that  class. 
Aptitudes  might  have  more  to  do,  in  all  families, 
and  financial  obstacles  less,  with  the  choice  of 
future  work  by  the  children. 

The  subject  of  population  and  birth  control  is 
intimately  related  to  the  proper  justification  of 
child-labor  prohibition.  It  has  sometimes  been 
objected  by  opponents  of  child-labor  laws  that  to 
prohibit  the  labor  of  children  may  so  limit  the 
incomes  of  some  families  as  to  deprive  the  children 
themselves  of  proper  food.  The  argument  runs 
to  the  effect,  therefore,  that  the  prohibition  of 
child  labor  may  be  more  cruel  than  the  permitting 
of  it.  The  families  affected  need  the  food,  the 
clothing,  etc.,  which  the  children  earn.  Particularly 
are  the  earnings  of  the  children  needed  when  the 
number  of  children  is  large  so  that  the  father 
cannot  properly  support  all.  Superficially  this  argu- 
ment   may    be    plausible.      But    the    fundamental 


Wages  and  Population  191 

consideration  which  it  overlooks  is  that  permitting 
child  labor  makes  families  large.  To  many  a 
father  willing  to  put  his  children  to  work  at  an 
early  age  these  children  have  become  an  economic 
advantage.  He  has  lived  in  comfort,  in  semi-idle- 
ness, perhaps  in  drunkenness,  off  of  the  earnings 
of  their  unhappy  child  efforts.  To  plead  the 
necessity  of  child  labor  as  an  aid  in  the  support  of 
such  families,  is  to  be  plead  the  necessity,  as  a 
palliative,  of  the  very  cause  (in  large  part)  of  the 
evil.  If  child  labor  is  sternly  prohibited  by  law,  the 
prohibition  has  the  advantage  of  putting  squarely 
upon  parents  the  responsibility  of  supporting  their 
children  and  of  discouraging  their  having  more 
children  than  they  can  comfortably  support.  Such 
a  policy,  coupled  with  unforbidden  dissemination 
of  methods  of  birth  control,  would  go  far  to  prevent 
multiplication  of  numbers  in  the  now  low-paid 
labor  groups,  with  the  consequent  low  wages,  poor 
living  and  absence  of  opportunity.  If  the  economic 
well-being  of  an  entire  community  is  to  be  main- 
tained at  a  high  level,  perhaps  nothing  is  so  im- 
portant as  to  establish  the  principle  that  those 
who  bring  children  into  the  world  must  provide 
these  children  with  a  childhood  not  wholly  devoid 
of  opportunity  and  of  happiness,  and  therefore,  by 
implication,  that  they  must  not  have  more  children 
than  can  be  so  provided. 


192        Earned  and  Unearned  Incomes 

§   4 
A  Side  Light  on  the  Interest  Problem 

The  chapters  on  interest"  have,  it  is  hoped,  made 
it  clear  that  interest,  provided  the  capital  for  the 
use  of  which  it  is  paid  is  not  used  in  anti-social 
ways,  is  earned  in  just  the  same  sense  as  are,  with 
a  like  proviso,  the  wages  of  labor.  The  waiting 
yields  a  service  to  the  community  worth  as  much 
as  the  interest  received,  as  truly  as  the  labor 
yields  a  service  worth  as  much  as  the  wages  re- 
ceived. The  person  who  works  and  saves  is,  to  the 
extent  that  this  saving  operates  in  aid  of  production, 
just  as  good  a  servant  of  the  general  welfare  as  the 
person  who  works  more  but  saves  less.  Contrary  to 
the  view  of  orthodox  socialism,  interest  as  such  is  no 
more  robbery  or  exploitation  than  wages.  Nor 
would  there  probably  have  arisen  so  considerable  an 
opposition  to  it  if  its  enjoyment  were  widely  distrib- 
uted among  the  masses  in  any  such  degree  as  the 
enjoyment  of  ivages.  Interest  appears  to  lack  justi- 
fication to  many  because  it  seems  to  be  connected 
with  a  narrow  class  interest. 

At  just  this  point  we  need  to  recur  to  our 
discussion  of  comparative  birth  rates.  The  reason 
why  large  classes  of  the  population  cannot  enjoy 
interest  is  because  their  wages  are  low  and  because 
their  families  are  large.  Their  wages  are  low 
because  they  have  many  competitors  in  their 
unskilled  work  and  they  have  many  competitors 
because  the  previous  generation  of  unskilled  labor- 
ers had   relatively  large  families   and   could   help 

17  Chapters  III  and  IV. 


Wages  and  Population  193 

few  of  their  children  into  better  paying  kinds  of 
labor.  Fewer  children  in  this  class  of  the  popula- 
tion would  make  accumulation  of  capital  possible 
to  them  in  just  the  same  way  that  it  would  make 
possible  the  investment  of  larger  sums  in  the 
industrial  training  of  their  children.  And  fewer 
children  among  wage  earners  of  this  class  would 
mean,  in  a  generation,  not  only  smaller  expenses 
for  the  bare  necessities  of  life,  but  also  larger 
wages  from  which  to  make  savings.  If  we  can, 
eventually,  stamp  out  exploitation  and  if  we  can, 
at  the  same  time,  intelligently  control  population 
changes,  there  need  be  no  reason  why  any  family 
may  not  have  some  accumulated  capital  and  receive 
an  interest  income  along  with  its  labor  income 
and,  at  the  same  time,  labor  incomes  may  reason- 
ably be  expected  to  become  less  unequal  than  now. 
If,  with  the  way  of  hope  thus  open  to  each  family, 
some  refuse  to  profit  by  it,  we  can  hardly  conclude 
that  posterity  will  be  benefited  either  in  stimulus 
to  ambition  or  in  the  greater  inheritance  of  desir- 
able traits,  by  a  policy  which  would  take  a  part 
of  the  earnings  of  the  ambitious,  the  capable,  the 
industrious,  the  far-sighted  and  the  saving,  in 
order  to  increase  the  already  too  numerous  progeny 
of  those  who  possess  none  or  few  of  these  virtues. 
There  is  no  intention  here,  to  suggest  that 
interest  or,  for  that  matter,  wages,  constitutes  an 
income  of  a  peculiarly  sacred  sort  so  as,  for 
example,  to  be  an  unfit  subject  for  taxation. 
Government,  which  serves  all  of  us,  needs  funds 
to  do  so  and,  if  no  better  and  adequate  sources  of 
revenue  can  be  found,  it  may  properly  enough  tax 


194        Earned  and  Unearned  Incomes 

both  interest  and  wages. i**  But  there  is  the  in- 
tention to  emphasize  the  similarity  of  interest  and 
wages  so  far  as  the  giving  by  the  recipient  of  a 
quid  pro  qiio  is  concerned,  and  to  suggest  that 
wider  and  unimpeded  spread  of  knowledge  and 
ideals,  increased  emphasis  on  parental  responsibil- 
ity, and,  along  with  these  things,  the  effective 
prohibition  of  all  forms  of  exploitation,  may  do 
much  that  so-called  corrective  taxation  has  been 
called  upon  by  its  advocates  to  do,  and  may  do  it 
better  and  with  less  of  offsetting  evil. 

§   5 
General  Wages  ayid  Populatiori 

Even  if  it  were  possible  to  get  the  most  desirable 
proportion  of  the  population  in  each  kind  of  work 
and  in  each  class  or  stratum  of  labor,  this  would 
not  alone  solve  the  population  problem;  population 
as  a  ivhole  must  be  reasonably  limited.  Invention 
may  for  a  while  go  on  so  rapidly  that  a  larger 
population  can  be  better  fed  than  a  smaller  one 
was  before.  Inventions  and  discoveries  of  some 
sorts  make  it  desirable  to  devote  more  time  to 
less  land,  for  example,  the  discovery  that  spraying 
trees  leads  to  their  yielding  of  more,  larger  ana 
better  fruit.  Inventions  and  discoveries  of  such 
a  kind  may  mean  that  a  larger  population  can 
secure  as  much  per  capita  as,  with  the  same 
degree  of  skill  and  knowledge,  a  smaller  popula- 

>*  Least  fif  all  can  any  class  able  to  pay  largely,  fairly  claim  ex- 
emption when  the  nation  is  in  peril  from  foreign  foes  and  when 
lives  must  be  sacrificed  as  \vell  as  incomes.  A  source  or  sources  of 
public  revenues  ordinarily  ideal  ma^  then  prove  insufficierit, 


Wages  and  Population  195 

tion  could  secure.  But  not  all  inventions  and 
discoveries  work  to  this  effect.  Some,  for  example 
the  invention  of  much  of  agricultural  machinery, 
enable  fewer  people  effectively  to  utilize  larger 
areas.  The  consequence  of  such  inventions  is  that 
a  large  population  is  relatively  superfluous,  that 
the  additional  men  add  relatively  little  to  the 
total  product  of  industry,  that  the  point  of  dimin- 
ishing returns  is  passed  when  with  the  same 
population  and  less  advance  in  the  mechanic  arts  it 
would  not  be  reached.  This  conclusion  is  not  in- 
consistent with  the  fact  that  the  inventions  in 
question  may  enable  the  existing  population  to  be 
supported  in  greater  average  comfort  than  before.^'* 
Our  conclusion  is  simply  that  the  gain  from  those 
inventions  which  enable  few  people  to  utilize  larger 
areas  would  often  be  greater  per  capita  were  pop- 
ulation smaller.  It  is  not  necessary,  therefore, 
to  show  that  increasing  population  always  involves 
increase  of  poverty,  to  make  reasonable  an  opposi- 
tion to  the  growth  of  numbers.  If  it  be  merely 
shown  that  per  capita  wealth  is  likely  not  to 
increase  as  rapidly  or  as  far  with  development  of 
the  arts  of  life,  in  the  case  of  a  larger  population 
as  in  the  case  of  a  smaller  one,  the  desirability 
of  the  smaller  population  may  be  sufficiently  es- 
tablished. 

But  what  is   our   standard   or   test   of   an   ideal 
population?     Would   we  prefer  that  there   should 

1^  Though  there  may  be  effects  on  distribution  such  that  land- 
owners as  such  derive  most  or  all  of  the  gain,  or  more  than  the 
gain.  Sec  Henry  George,  Progress  and  Poverty,  Book  IV,  Chapter 
III, 


196        Earned  and  Unearned  Incomes. 

be  in  the  United  States  75  million  very  happy 
persons,  150  million  moderately  happy  persons, 
or  300  million  persons  whose  average  happiness  is 
slightly  better  than  zero?  Is  the  greatest  aggregate 
surplus  of  pleasure  over  pain  our  desideratum  or 
is  the  greatest  /jcr  cainta  surplus  of  pleasure  the 
thing  to  be  aimed  at?  The  former  would  probably 
be  realized  with  a  density  of  population  somewhat 
greater  and  a  per  capita  income  somewhat  less 
than  the  latter.  If  we  suppose  that  the  greatest 
per  capita  happiness  is  the  thing  to  be  sought,  it 
is  likely  that  the  desirable  degree  of  density  of 
population  is  such  as,  on  a  given  stage  of  techno- 
logical development,  will  make  for  the  largest 
possible  per  capiita  product  with  the  smallest  per 
capita  eifort.^'^  But  in  any  case  and  according  to 
any  reasonable  test  the  ideal  population  is  almost 
certainly  not  the  maximum  possible  population. 
It  is  not  to  be  expected  that  the  ideal  population 
will  ever  be  exactly  attained  for  the  world  as  a 
whole  or  for  any  part  of  the  world.  If  the  number 
of  children  to  a  family  comes  to  be  a  matter  of 
individual  judgment  and  choice,  with  free  diffusion 
of  knowledge  as  to  how  the  desired  number  may 
be  made  the  actual  number,  population  will  probably 
tend  to  adjust  itself  in  the  direction  of  the  greatest 
per  capita  happiness.  It  is  to  the  interest  of  the 
individual  and  of  the  family  that  individual  well- 
being    and    family    well-being    should    become    the 

2'^  Allowance  must  be  made  for  the  fact  that  what  is  the  ideal 
population  may  change  as  knowledge  of  the  arts  of  life  changes. 
The  ideal  population  in  this  generation  may  not  be  the  population 
which  is  best  for  the  men  and  women  of  this  generation  but  may  be 
one  which  can  easily  grow  into  or  decline  into  the  population  which 
is  best   for   later   generations. 


Wages  and  Population.  197 

greatest  possible.  It  is  not  unreasonable  to  suppose 
that  the  greatest  aggregate  net  happiness  would 
also  be  greater  were  births  so  restricted  as  to 
avoid  some  of  the  abject  poverty  which  now  results 
from  too  rapid  increase  in  certain  families  and 
classes. 

§   6 

Immigratio7i  and  Wages 

Even  if  the  people  of  a  country  adopt  a  rational 
attitude  toward  the  population  problem,  the  possi- 
bility of  overpopulation  from  immigration  has 
still  to  be  faced.  Thus,  a  policy  of  limiting  off- 
spring among  the  present  population  in  the  United 
States  in  the  hope  that  the  next  generation  would 
not  find  competition  too  severe,  might  have  its 
intended  results  negatived  by  an  inflow  of  labor 
from  other  countries.  The  children  of  races  which 
had  applied  no  such  limitation  might  come  in  to 
inherit,  in  part,  the  land  whose  small  population 
the  intelligence  of  its  people  had  made  possible, 
and  to  decrease  largely  the  gain  resulting  from 
such  intelligence.  Immigration  may  ofi'er  a  contin- 
uing prospect  of  gain  to  the  landowners  of  a 
country  but  it  holds  out  no  general  promise  of 
gain  to  native  wage  earners.-^ 

§   7 
Summary 

We  have  seen  that  wages  are  fixed  by  demand 
and  supply  at  such  a  point  that  wage-earners  tend 

21  Cf.  the  author's  Principles  of  Commerce,  New  York  (Macmil- 
lan),  1916,  Part  II,  Chapter  VI,  §  3,  footnote. 


198        Earned  and  Unearned  Incomes. 

to  receive  the  marginal  value  product  of  their 
labor.  The  value  of  the  goods  produced  by  some 
classes  of  labor  is  low  and  the  wages  of  the  labor- 
ers are  low  simply  because  these  laborers  are 
numerous  and  products  of  their  labor  relatively 
too  plentiful.  These  classes  of  workers  have  so 
little  surplus  spending  power  that  they  can  not 
usually  afford  the  cost  of  raising  their  children 
out  of  their  own  class.  Nor  do  they  sufficiently 
limit  the  number  of  their  children,  on  the  average, 
to  reduce  the  labor  supply  in  their  own  class  in 
the  next  generation  and  so  make  necessary  higher 
wages  for  that  class.  Limitation  of  size  of  families 
would  help  them  to  aid  their  children  more  effect- 
ively to  prepare  for  other  work  and,  even  if  it 
did  not,  would  eventually  raise  the  wages  for  the 
work  in  question.  A  better  relative  adjustment 
of  numbers  in  different  labor  groups  would  also 
make  possible  a  more  widespread  accumulation  of 
capital.  Interest  is  earned  as  surely  as  wages  are 
earned,  if  the  test  is  the  giving  of  a  quid  pro  quo 
by  the  recipient.  But  interest  is  not  so  generally 
enjoyed  and  hence  is  looked  on  by  the  masses  with 
less  favor.  The  ideal  perhaps  is  that  every  family 
should  receive  an  interest  income  as  well  as  a 
wage  income.  Population  in  general  needs  to  be 
limited  as  well  as  population  in  special  groups, 
in  order  that  average  prosperity  and  happiness 
may  be  high.  This  may  necessitate  for  low  birth 
rate  countries  restrictions  on  the  too  free  immigra- 
tion from  countries  whose  inhabitants  multiply 
with  little  regard  to  economic  consequences. 


CHAPTER  VI 

THE  RENT  OF  LAND  AND  ITS  TAXATION 

§   1 
Land  Rent  as  a  Marginal  Product  of  Land 

In  the  previous  chapter^  we  had  occasion  to 
suppose  the  existence  of  a  piece  of  land  on  which 
the  labor  of  five  men  working  with  the  aid  of 
improvements  and  equipment  worth  $5,000,  pro- 
duced a  yearly  product  above  repair  and  deprecia- 
tion costs,  of  $2,200.  Of  this  $2,200,  wages  consti- 
tuted $1,500,  interest  (at  8  per  cent.)  $400,  and 
$300  a  year  remained  as  rent.  This  $300  measures, 
roughly,  the  amount  of  rent  the  owner  could 
secure  from  a  tenant.  It  is  the  surplus  produced 
on  the  land,  above  the  remuneration  of  the  labor 
and  waiting  used.  But  we  have  seen  that  the 
remuneration  of  waiting,  the  interest  on  capital, 
is  fixed  by  demand  and  supply  at  a  point  where  it 
equals  the  marginal  productivity  of  waiting.-  We 
have  likewise  seen  that  the  remuneration  of  labor 
is  fixed  by  demand  and  supply  at  a  point  where 
it  equals  the  marginal  product  of  labor.^  Hence, 
to  say  that  a  piece  of  land  yields  per  year  c 
surplus  of  $300  over  interest  to  waiting  and  wages 
of  labor  is  to  say  that  it  yields  a  surplus  of  $300 
above  the  marginal  product  of  such  waiting  and 

1  Chapter  V,  §   i. 

2  Chapter   IV. 

3  Chapter  V,  §   i. 

(199) 


200        Earned  and  Unearned  Incomes 

labor.  Let  us  suppose  this  particular  piece  of 
land  to  be  non-existent.  Then  the  labor  and 
capital  applied  upon  it  must  needs  be  applied  on 
poorer  or  less  well  situated  land  not  previously 
used,  or  this  labor  and  capital  must  be  applied  to 
using  more  intensively  land  already  in  use.  Applied 
in  either  of  these  ways,  such  labor  and  capital 
would  produce  $300  less  than  could  be  produced 
if  the  labor  and  capital  were  applied  to  the 
$2,200  yielding  land.  In  other  words,  the  $300 
is  the  product  of  this  particular  piece  of  unimprov- 
ed land  in  the  sense  that  the  existence  and  use  of 
this  piece  of  land  makes  it  possible  for  a  product 
$300  larger*  to  be  secured  with  no  more  labor 
and  waiting,  simply  because  the  land  resources  to 
which  the  labor  and  waiting  are  applied  are  that 
much  better  than  the  margin  at  which  the  labor 
and  waiting  in  question  must  otherwise  be 
applied.  But  although  $300  may  thus  be  regarded 
as  a  contribution  of  the  land  to  production,  it  is  not 
on  that  account  to  be  regarded  as  a  contribution  of 
the  land-oivner  to   production. 

It  is  to  be  emphasized  that  the  rent  of  city 
land  is  determined  in  just  the  same  way  as  the 
rent  of  land  in  the  country.  The  well-located 
merchant  derives  a  larger  return  from  his  business 

*  By  way  of  qualification  it  may  be  said  that  this  differential  is 
not  fixed  but  is  greater  for  some  potential  users  of  the  land  than 
for  others.  Some  users  may  be  able  to  gain  from  the  use  of  a 
piece  of  superior  land  much  more  than  they  have  to  pay.  To  others, 
the  differential  is  less  than  the  rent  and  they  will  presumably  use 
inferior  land.  The  marginal  productivity  of  the  land  is  its  pro- 
ductivity to  the  user  who  is  just  induced  to  hire  it  and  who,  if 
rent  were  greater,  would  have  to  resort  to  poorer  land. 


Rent  of  Land  and  Its  Taxation         201 

as  a  retailer  or  a  jobber  by  virtue  of  his  superior 
situation.  So,  also,  the  manufacturer  whose  busi- 
ness is  wisely  located  in  relation  to  sources  of 
power  and  to  shipping  facilities  derives  from  such 
a  location  advantages  for  which  he  may  be  willing, 
if  necessary,  to  pay  a  high  rent  and  for  which,  if 
the  desired  location  is  equally  advantageous  to 
others,  he  will  have  to  pay  such  a  rent.  In  the 
case  of  either  country  or  city  land  it  is  here 
intended  to  regard  as  land  rent  only  the  amount 
which  is  the  marginal  product  of  the  land  as 
such.  Interest  on  the  cost  of  improvements, 
whether  swamp  draining  and  fertilizing  in  the 
case  of  farm  land  or  filling  and  leveling  in  the 
case  of  city  land,  is  not  properly  a  part  of  the 
rent  of  land  but  is  a  return  on  capital  investment. 
The  amount  of  rent  which  landowners  can  get 
for  the  use  of  their  land  appears  to  be  pretty 
definitely  fixed  by  the  conditions  of  demand  and 
supply.  Attention  is  commonly  called,  by  econom- 
ists, to  the  fact  that  a  tax  on  land  rent  can  not  be 
shifted.  The  owner  of  the  land  cannot,  when 
a  tax  is  levied,  get  any  more  rent.  The  tax  does 
not  increase  the  marginal  product  of  the  land.  It 
does  not  decrease  the  marginal  product  of  waiting 
or  the  marginal  product  of  labor.  It  can  not  make 
interest  lower  or  wages  lower.  It  cannot,  there- 
fore, increase  the  difference  between  the  total 
product  of  the  land  and  the  amount  going  to 
capitalists  and  wage  earners.  It  does  not  make 
land  space  any  scarcer.  The  tax-paying  land- 
owner can  even  less  afford  to  keep  his  land  idle 
than  the  landowner  who  is  untaxed.     It  does  not 


202        Earned  and  Unearned  Incomes. 

decrease  the  quantity  of  goods  produced  on  the 
land  and  does  not  increase  prices.  It  simply 
leaves  the  landowner  with  a  smaller  income  by  the 
amount  of  the  tax  substraction.  A  tax  on  interest 
might  diminish  saving  and  make  interest,  eventual- 
ly, higher.  A  tax  on  wages,  especially  if  heavy, 
might  diminish  population  and  so  make  wages,  in 
a  later  generation,  larger.'"'  But  a  tax  on  rent  can 
have  no  effect  other  than  to  diminish  the  amount 
of  revenue  received  by  landowners  and  give  this 
revenue  to  the  general  public.**  It  should  be  said, 
however,  by  way  of  qualification,  that  when  the 
so-called  "rent"  results  not  chiefly  from  a  favor- 
able situation  or  other  conditions  independent  of 
the  owner's  labor  but  in  part  from  a  fertility 
which  has  to  be  maintained  by  the  owner,  some 
shifting  may  take  place.  (Return  on  improve- 
ments due  to  labor,  is  properly  interest  on  capital.) 
But   a   tax   upon   the   situation   rent   or   value   of 

^  This  suggests  the  Physiocratic  doctrine  that  all  taxes  must  in- 
evitably be  borne  by  the  landed  proprietors  of  a  country,  through 
diminished  population  and  lower  rents.  The  conclusion  may  be 
(and  may  not  be)  largely  true,  if  we  include  owners  of  urban,  etc., 
as  well  as  agricultural  land,  as  the  Physiocrats  did  not.  But  a  tax 
on  wages  thus  shifted  to  landowners  will  fall  upon  them  in  very 
different  proportions  than  a  direct  tax  levied  as  a  percentage  of 
rental  value.  The  former  will  fall  much  more  heavily  in  proportion 
on  the  owners  of  near-marginal  land  and  the  latter  will  fall  with 
equal  proportionate  weight  on  the  owners  of  superior  land. 

^  To  appropriate  rent  in  taxation  provided  land  is  used  for  some 
purposes  but  not  if  it  is  used  for  other  purposes,  would  discourage 
the  former  kinds  of  uses  and  encourage  the  latter.  See  the  author's 
Principles  of  Commerce,  New  York  (Macmillan),  1916,  Part  III, 
Chapter  III,  §  4.  Such  a  tax  must,  therefore,  result  in  a  degree 
of  shifting. 


Rent  of  Land  and  Its  Taxation         203 

land,  or  upon  the  rental  value  resulting  from  any 
natural  and  indestructible  advantages,  falls  upon 
the  owner  and  upon  no  one  else. 

§   2 
Land  Rent  Versus  Capital  Interest 

An  examination  of  the  justice  of  special  land- 
value  taxation  may  advantageously  begin  with  a 
brief  consideration  of  the  difference  between  rent 
and  interest.  The  distinction  between  them  has 
been  elaborated  elsewhere^  and  need  not,  perhaps, 
be  long  dwelt  upon  here.  It  is  sometimes  said  that 
the  rent  of  land  is  no  less  interest  than  the  return 
on  other  capital,  since  the  return  on  land  can  be 
viewed  as  a  given  percentage  on  a  given  valuation, 
while  on  the  other  hand,  the  interest  on  other 
capital  can  be  viewed  as  an  absolute  amount  in 
dollars  per  machine  or  factory,  just  as  land  rent 
is  viewed  as  so  many  dollars  per  building  lot  or 
per  acre  a  year.*  But  more  fundamentally  there 
is  a  difference,  despite  the  superficial  resemblance, 
between  situation  rent  and  capital  interest.  The 
return  on  land  should  be  looked  at  as  an  absolute 
amount  measured  and  determined  by  the  surplus 
over  production  on  the  extensive  or  intensive  mar- 
gin. It  is  not  determined  by  the  value  of  the  land. 
Neither  has  the  value  of  land  as  such,  i.  e.,  its  situa- 
tion value  apart  from  improvements,  any  relation 
to  any  cost  of  production,  since  the  land  was  not 

7  Chapter  IV,  §§  3  and  5. 

8  This  view  seems  to  be  presented  in  Fisher,  The  Nature  of  Capi- 
tal and  Income,  New   York    (Macmillan),   1906,   pp.   184-188. 


204        Earned  and  Unearned  Incomes. 

humanly  produced.  On  the  contrary,  the  value 
of  the  land  can  be  arrived  at  only  by  discounting 
its  expected  future  rents  or  returns  at  some 
previously  found  rate  of  interest.  Thus,  a  piece  of 
land  which  would  yield  $5,000  per  year  net  rent 
(above  taxes,  wages  of  labor  employed,  interest 
on  the  capital  invested  in  buildings  and  other 
improvements,  and  insurance)  would  be  worth,  if 
interest  were  5  per  cent,  $100,000.  Were  the 
current  rate  10  per  cent,  such  a  piece  of  land 
would  be  worth  but  $50,000. 

With  equipment  of  the  producible  and  reproduci- 
ble kind,  however,  the  relation  between  capital 
and  income  value  is  not  the  simple  one  above 
outlined.  The  value  of  such  capital,  though  not 
unaffected  by  the  value  of  its  expected  services, 
is  very  directly  related  to  the  cost  of  its  production. 
Buildings  of  a  type  costing  $5,000  each  will  hardly 
be  put  up  to  sell  for  much  less,  as  a  rule,  by  the 
builders.  Nor,  so  long  as  the  alternative  is  open 
to  him  of  supervising  the  construction  of  a 
similar  building,  will  a  possible  buyer  care  to  pay 
a  great  deal  more.''  The  value  of  a  building  is 
determined  then,  in  large  part,  by  the  expenses, 
such  as  wages,  of  producing  the  materials  and  of 
putting  it  up;  and  these  wages  are  determined,  in 
the  last  analysis,  by  the  existence  of  alternative 
lines  of  activity  open  to  the  wage-earners,  while 
the  other  costs  are  determined  by  the  alternative 

8  If  he  purchases   a  building  already  constructed   he  pays,  in   its 
cost,  for  the  supervision  of  its  construction. 


Rent  of  Land  and  Its  Taxation         205 

uses  to  which  the  land  or  capital  which  must  be 
used  in  producing  the  materials  might  be  put.^" 
Since  the  value  of  produced  and  reproducible 
capital  is  thus  in  large  part  fixed  directly  by  its  cost 
of  production,  the  assertion  that  interest  is  in 
large  part  determined  by  the  rate  of  productivity 
of  capital  does  not  involve  reasoning  in  a  circle. 
Interest  is  5  per  cent  because,  for  one  and  perhaps 
the  most  important  reason,  capital  worth  $10,000 
will  produce  an  annual  net  income  of  $500.  It 
therefore  appears,  to  sum  up  our  conclusions  thus 
far,  that  the  value  of  produced  capital  depends  in 
a  considerable  degree  on  cost  of  production,  that 
the  ratio  between  the  value  of  capital  and  its 
income  is  an  important  factor  in  determining 
the  general  long-run  rate  of  interest,  and  that 
this  rate  of  interest  is  an  essential  element  in  the 
valuation  of  land. 

§   3 

Land  Rent  as  an  Unearned  Income 

It  is  but  a  short  step  to  the  conclusion  that  the 
accumulators  of  produced  capital  may — and  in 
many  cases  doubtless  do — add  to  the  volume  of  the 
annual  aggregate  income  of  society  as  much  as 
they  take  out  of  this  income  in  interest;  while  the 
owners  of  land,  as  such,  contribute  no  service  in 
return  for  their  income.  Whereas,  in  the  case  of 
produced  capital,  the  public  (except  in  certain 
cases,    numerous    enough    no    doubt,    where    the 

10  Cf.  Davenport,  Economics  of  Enterprise,  New   York    (Macmil- 
lan)    1913,  pp.   6i-66- 


206        Earned  and  Unearned  Incomes. 

capital  is  wastefully  or  injuriously  used)  pays 
the  owner  for  a  service  which,  without  his  saving 
(or  the  saving  of  someone  whose  right  to  pay- 
ment has  been  transferred  to  him),  would  not 
have  been  enjoyed,  in  the  case  of  land  the  pay- 
ment is  made  for  a  benefit  which  is  dependent  on 
no  individual's  saving  or  effort  and  a  benefit  for 
which,  therefore,  no  individual  is  responsible.  In 
the  one  case  the  community  pays  for  a  service 
which  is  actually  rendered  to  it.  In  the  other  case 
it  pays  people  who  have,  in  the  capacity  in  which 
they  are  paid,  rendered  no  service.^^ 

To  avoid  any  possible  misunderstanding,  let  it  be 
emphasized  that  land  rent  as  here  defined  does  not 

^^  The  view  presented  so  consistently  in  this  book  that  incomes 
received  not  in  payment  for  service  rendered  lack  social  justification 
will,  of  course,  not  be  accepted  by  the  Junker  type  of  mind.  More 
or  less  plausible  arguments  may  again  be  advanced  as  they  have 
often  been  before,  in  favor  of  incomes  to  privileged  classes.  It 
will  be  alleged  that  members  of  these  classes,  not  having  to  worry 
about  their  livelihood,  will  become  efficient  officers  of  state,  scholars 
devoted  to  research,  and,  in  other  ways,  profitable  social  servants. 
To  the  argument  that  if  a  class  is  to  be  supported  without  definite 
regard  to  a  special  service  for  which  their  income  is  received,  in 
order  that  such  results  may  accrue,  the  public  might  select  in  a 
better  way  the  individuals  who  should  make  up  this  class,  it  will 
doubtless  be  replied  that,  in  practice,  the  public  will  not  select  in 
any  such  manner  as  to  give  equally  good  results.  Or  the  sup- 
porters of  a  privileged  aristocracy  may  go  a  step  farther  and  de- 
fend its  existence,  not  by  virtue  of  any  alleged  superior  social  serv- 
ice, but  as  being  good  in  itself,  as  a  class  for  the  good  of  which 
other  classes  exist,  as  constituting  "the  backbone  of  the  state."  To 
one  who  accepts  either  view  above  outlined,  no  argument  against 
exploitation  will  be  convincing,  especially  if  the  exploitation  is  of 
an  ancient  sort  and  has  the  prescriptive  sanction  of  long  usage,  as 
is  the  case  with  land  rent. 


Rent  of  Land  and  Its  Taxation         207 

mean  merely  the  sum  paid  by  a  tenant  to  an 
owner,  for  the  use  of  land,  but  equally  the 
amount  received  by  the  person  who  himself  uses 
his  own  land,  in  excess  of  wages  for  his  labor 
and  interest  on  his  capital.  This  rent  comes  to 
him  in  money  when  he  sells  the  goods  or  services 
which  the  land  produces.  He  is  paid,  thus,  by 
others,  for  benefits  which  not  he  but  the  land 
renders.  The  community,  in  buying  from  him, 
pays  him  for  more  than  the  service  he  and  his 
"waiting"  render  them. 

But,  it  may  be  said,  at  least  many  of  the  present 
landowners  are  persons  who  have  made  their 
savings  from  what  they  have  earned  and  have 
chosen  to  invest  their  savings  in  land  rather  than 
elsewhere.  Have  they  not,  in  their  savings,  given 
the  community  as  much  value  as  they  draw  in 
rent?  The  answer  may  well  be  that  they  have 
given,  to  that  part  of  the  community  from  whom 
their  rent  income  is  derived,  nothing  whatever. 
If  A,  who  has  saved  $10,000,  uses  it  to  buy  a 
piece  of  land  from  B,  he  is  merely  paying  B  for 
the  privilege,  previously  enjoyed  by  B,  of  receiv- 
ing rent  from  others  for  the  use  of  something 
that  neither  he  nor  any  other  individual  produced 
and  the  use  of  which  would  be  equally  available 
had  no  owner  or  purchaser  of  land  ever  been 
born.  In  turn,  B  has  now  the  $10,000  of  accumu- 
lations and  it  is  quite  possible  that  he  may  use 
it  in  some  way  that  will  increase  the  annual 
product  of  industry.  If  so,  the  community,  or 
some  members  of  the  community,  will  come  to  be 
paying  B,  in  interest  on  capital,  for  services  which. 


208        Earned  and  Unearned  Incomes 

without  A's  saving,  would  not  have  been  available, 
while  they  will  be  paying  A,  in  rent,  for  benefits 
from  the  use  of  land,  which  are  not  due  to  any 
individual's  work  or  savings.  If,  before,  the 
community  was  paying  the  landowner  B  a  rent 
while  getting  no  service  that  could  fairly  be 
regarded  as  coming  from  him,  now  it  is  making 
payments  to  both  A  and  B,  as  rent  and  interest 
respectively,  and  receiving  services  in  return  from 
only  one.  If,  before,  B  the  landowner  was  a 
pensioner  to  whom  the  community  gave  something 
for  nothing,  now  A  has  become  the  pensioner, 
having  bought  out  B,  and  is  receiving,  from  the 
rest  of  the  community,  something  for  nothing.  For 
it  should  be  clearly  evident  that  the  $10,000  paid 
to  B  for  the  land  is  not  a  service  rendered  to  C, 
D,  or  E,  who  are  the  persons  that  have  to  pay 
A  for  the  use  of  the  land.  Yet  much  of  emphasis 
is  commonly  directed  to  the  assertion  that  the 
land-using  part  of  the  community  ought  to  pay 
rent  to  landowners  because  these  landowners  have 
in  many  cases  paid  previous  landowners  for  the 
land  and  despite  the  fact  that  none  of  the  land- 
owners in  the  series  can  be  said  to  have  rendered 
any  service  to  those  from  whom  they  collect  rent 
payment.  In  other  words,  it  is  asserted  that  C, 
D,  and  E  ought  to  be  obliged  to  pay  A  for  no 
service  rendered  by  him  or  by  anyone,  simply 
because  A  previously  paid  $10,000,  not  to  C  or  D 
or  E,  but  to  B.  Is  such  a  doctrine  good  utilitarian- 
ism?    Is  its  application  good  social  policy? 


Rent  of  Land  and  Its  Taxation         209 

§   4 

Improvements    by    Sjjecial    Assessme^its    and    the 
Right  of  Landowners  to  a  Rental  Return 

Nevertheless,  to  assert  that  in  practice  the  land- 
owner, as  such,  never  performs  any  service  for 
which  he  is  entitled  to  a  return  in  payment  for 
the  use  of  his  land  is  going  too  far.  If  he  is 
entitled  to  nothing  else,  he  is  usually  entitled  to  a 
return  on  the  cost,  to  him,  of  improvements  (such 
as  cutting  through  and  paving  streets)  met  by 
special  assessments.  These  assessments  are  custom- 
arily made  on  all  owners  of  land  where  a  street  is 
to  be  put  through  or  paved,  on  the  theory  that 
they  derive  a  special  benefit  from  the  improvement, 
a  theory  which  is  generally  in  accord  with  the  facts. 
It  would  seem  that  there  is  much  the  same 
reason  for  the  owners  of  land  which  is,  in  effect, 
improved  by  such  expenditures,  to  meet  them  as 
there  is  for  farmers  to  pay  the  cost  of  fencing  and 
manuring  their  own  land. 

That  the  benefit  of  this  street  building  (as  of 
social  growth)  goes  to  the  landowner  as  such,  and 
not  to  the  owner  of  buildings  on  the  land,  should 
become  apparent  when  it  is  realized  that  a  build- 
ing, apart  from  its  situation,  can  hardly  go  much 
above  the  cost  of  putting  up  another  like  it. 
Suppose  two  building  lots  side  by  side,  each 
worth  $2,000.  On  one,  a  $5,000  house  is  put.  The 
other  stands  vacant.  If  the  building  of  a  street 
or  the  growth  of  the  community  makes  the  combined 
house  and  lot  worth  $9,000,  is  not  the  added  $2,000 
an  increase  in  the  value  of  the  land?    If  there  is  no 


210        Earned  and  Unearned  Incomes 

change  in  the  cost  of  putting  up  such  a  house,  will 
not  the  adjoining  land  (on  which  an  exactly  sim- 
ilar house  can  be  built  for  $5,000,  to  sell,  with  the 
lot,  for  $9,000)  immediately  come  to  be  worth 
$4,000?  A  house  or  other  building  unwisely  located 
where  it  cannot  be  used  may  come  to  have  less 
value  than  its  cost,  by  the  necessary  expense  of 
moving  it,  or,  if  it  is  not  movable  to  a  desirable 
locality,  by  an  indefinite  amount.  But  a  house, 
as  such,  can  hardly  increase  in  value  much  above 
its  cost  of  duplication.  Analysis  seems  to  show 
that  the  increase  inheres   in  the  site. 

If,  then,  on  the  basis  of  this  fact,  the  owner  of 
land  is  compelled  to  bear  the  cost,  or  most  of  the 
cost,  of  the  improvements  made,  it  seems  but  rea- 
sonable that  he  should  be  allowed  to  enjoy  some 
return  on  his  investment  in  the  expense  of  paving 
or  other  improvement,  if  any  such  return  is  forth- 
coming. This  does  not  mean  that  he  is  entitled  to 
secure  all  the  value  that  results  from  social  growth, 
or,  perhaps,  any  of  the  value  so  resulting,  but  it 
may  mean  that  he  should  be  regarded  as  the  owner 
of,  and  is  entitled  to  interest  on,  the  difference  be- 
tween what  the  value  of  the  land  in  question  would 
be  to  a  prospective  purchaser  by  whom  the  costs 
of  improvement  had  still  to  be  met,  and  the  value 
to  a  purchaser  after  such  improvements  have  been 
made.  In  short,  the  investor  is  entitled  to  a 
return — if  the  land  can  ever  be  made  to  yield  it — 
on  the  expense  to  him  of  the  special  assessments. 

It  seems  clear  enough  to  the  writer  that  a  not 
very  excessive  rate  on  such  expenditures  for  street- 
making,  etc.,  will  compensate  owners  on  the  aver- 


Rent  of  Land  and  Its  Taxation         211 

age  for  any  risks  that  their  land  may,  in  certain 
contingencies  of  population-shifting,  yield  less  than 
an  average  return  on  such  expenses.  If,  however, 
a  group  of  lot-owners  take  steps  to  have  a  street 
cut  through  long  before  there  is  need  of  it  and 
therefore  find  that  a  return  on  this  cost  cannot  for 
some  time  be  had,  it  does  not  follow  that  these 
owners  are  entitled  to  get,  out  of  the  increased 
value  which  later  may  result  from  social  growth, 
all  the  interest  lost  during  the  interval  of  waiting. 
That  the  value  of  city  land  usually  includes  more 
than  can  be  accounted  for  by  the  expense  of  such 
improvements  is  evident  if  we  call  to  mind  the  value 
of  well-situated  land  where  such  local  improvements 
have  not  yet  been  made.  A  piece  of  land  in  a 
great  city,  situated  where  the  building  of  a  street 
was  contemplated  but  not  begun,  might  well  be 
less  valuable  by  only  about  the  cost  of  the  necessary 
assessments  than  if  the  street  were  there.  With- 
out doubt  it  is  sometimes  true  that  improvements 
such  as  street  construction  start  the  fashion  of 
living  in  a  given  section  of  a  city  and  so  bring  up 
the  value  of  sites  there  by  far  more  than  the  cost 
of  the  improvements.  But  it  is  also  true  that  the 
outward  pressure  of  population  or  the  building  of 
a  railroad  or  trolley  line  gives  value  to  the  un- 
improved land  in  the  absence  of  streets,  and  makes 
the  putting  through  of  the  streets  worth  while. 
In  this  latter  case  the  causal  influence  runs  the 
opposite  way.  It  is  the  conditions  leading  to 
increased  value,  and  the  contingent  possibility  of 
deriving  from  the  land  an  income  previously  not 
obtainable  even  if  improvements  had  been  made, 
that  give  rise  to  the  street-cutting  movement. 


212        Earned  and  Unearned  Incomes 

Our  conclusion  seems  to  be  that  owners  of 
land  are  entitled  to  a  return  on  their  investments 
in  improvements,  such  as  special  assessments  for 
cutting  streets,  in  the  same  sense  and  to  the 
same  degree  that  they  are  entitled  to  a  return 
on  the  cost  of  building  houses  or  factories;  that, 
however,  they  are  no  more  entitled  to  a  socially 
guaranteed  return  in  the  one  case  than  in  the 
other  ;^^  and  that  there  is  no  reason  why  they 
should  be  allowed  more  than  enough,  on  the  basis 
of  such  expenditures,  to  make  the  expenditures 
worth  while.  It  does  not  follow  that  the  sums 
required  as  special  assessments  or  purposely  in- 
vested by  land  speculators  in  street  building,  etc., 
are  not  fairly  subject  to  tax  in  the  same  way  as 
any  property  is  subject  to  tax,  but  only  that 
whatever  reasons  there  may  be  for  special  taxa- 
tion of  land  values  in  general  do  not  apply 
to  the  part  of  land  values  clearly  due  to  such 
investments  any  more  than  they  apply  to  the 
part  of  farm  land  values  due  to  the  owners' 
expenditures  in  fertilization. 

§  5 
Other  Services  of  City  Landowners 

Are  there  any  other  expenses  met  or  services  per- 
formed by  the  city  landowner  which  are  to  be 
regarded  from  the  viewpoint  of  the  land-value- 
taxation  philosophy  as  entitling  him  to  some  ex- 
emptions?   Does   the   landlord,   for   instance,   per- 

^2  Except  as  the  community  compels  them  to  make  improvements 
at  their  expense  in  advance  of  their  own  desire  to  do  so. 


Rent  of  Land  and  Its  Taxation         213 

form  a  service  worthy  of  a  share  of  economic  rent 
by  "managing"  the  land?     Is  the  joint  activity  of 
landowners  in  a  given  section,  in  determining  the 
class  or  race  of  tenants  who  may  live  in  such  a 
section,  or  attending  to  other  matters  of  common  in- 
terest, a  service  entitling  them  to  the  enjoyment  of 
rent?    Some  of  this  activity  or  attention  is  needed 
only  when  the  land  is  used  for  residential  purposes, 
and  perhaps  might  be  given,  under  some  arrange- 
ment for  a  percentage  consent  in  favor  of  new 
residents,  by  tenants  instead  of  by  landowners  as 
such,  or,   as   is  sometimes  the   case   in   a   limited 
degree,  by  municipal  ordinance.     The  desired  pro- 
tection  of  tenants  in   the  matter   of  neighbors   is 
but   inadequately   given   when   even   two   or   three 
landlords,  by  departing  from  a  general  understand- 
ing, choose,  for  a  profit,  to  admit  undesirables  as 
tenants     or     purchasers.      Municipal     protection 
might  not,  in  a  democratic  community,   be  much 
better,  but  it  probably  would  not  be  much  worse. 
At  any  rate,  any  service  of  this  sort  yielded  by 
landowners   does   not   entitle   them   to    more   than 
a  very  small  fraction  of  the  annual  rent  of  the 
land.      To   say   that   it   is   worth   all   the   rent   in 
every  case  is  to  say  that  it  is  worth  much  more 
in   a  metropolis   than   in   a   small   town.     And   to 
say  that  all  the  rent  is  earned  by  such  service  is 
to  say  that  the  cost  and  trouble  of  rendering  the 
service  so  offsets  the  rent  as  to  make  the  value 
of  the  land    (the  amount  that  a  purchaser  would 
pay  for  the  future  enjoyment  of  the  rent)   zero. 

Another  view  is  that  the  rent  of  land,   instead 
of  being,   aside   from   interest   on    special   assess- 


214        Earned  and  Unearned  Incomes. 

ments,  altogether  an  unearned  increment,  is  partly 
a  compensation  for  risk  and  a  stimulus  to  seek 
out  and  bring  into  use  desirable  locations.  In  such 
a  view,  it  might  be  argued  that  the  real  estate 
dealers  who  develop  a  new  section  of  a  city  or  a 
city  suburb  for  residential  purposes  risk  getting  but 
an  inadequate  return;  or  the  capital  put  into  im- 
provements may  be,  if  the  new  section  proves 
to  be  wholly  unpopular,  entirely  lost.  Must  there 
be  a  chance  for  a  corresponding  gain  of  the  so- 
called  unearned-increment  variety  in  order  that 
the  improvements  desired  shall  be  made?^^  And  if 
the  possibility  of  surplus  gain  needs  to  be  kept 
open  to  the  land  speculator,  must  this  gain  include 
all  the  rental  value  of  the  land  for  all  future  time? 
Is  the  fact  that  a  given  speculator  foresaw,  earlier 
than  others,  the  possibility  of  developing  certain 
sites,  and  thus  hastened  the  flow  of  business  or 
population  to  them,  a  reason  why  later  generations 
of  business  people  or  of  residents,  to  whom  the 
early  bringing  into  use  of  the  land  is  no  advantage, 
should  have  to  pay  him  for  the  privilege  of  working 
or  living  on  it?  Of  what  service  is  such  earlier 
development  to  these  later  generations,  that  they 
should  have  to  pay  an  extra  rent  for  the  space 
used,  in  order  to  compensate,  for  an  early  risk  of 
loss,  landowners  or  the  descendents  of  landowners 
who  took  risk  by,  possibly,  premature  building  in 
a  new  section?  So  long  as  this  section  is  now 
built  up  and  available  for  business  or  residence, 
its  having  been  built  long  before  their  use  of  it 
is  probably  of  no  advantage  to  present  users.     If 

1'' Cf.  Hadley,  Economics,  New  York  (Putnam),  1896,  pp.  287-291. 


Rent  of  Land  and  Its  Taxation         215 

these  present  users  must  pay  more  in  consequence 
of  such  early  development,  the  landowner  is  pre- 
sumably receiving  payment  from  persons  to  whom 
neither  he  nor  his  predecessors  have,  as  land- 
owners, rendered  a  corresponding  service. 

In  the  case  of  inventions  and  patents,  we  limit 
the  time  during  which  the  inventor  is  to  enjoy 
a  special  profit  on  his  idea,  our  philosophy  being — 
partly,  at  least — that  after  a  few  years  the  general 
progress  of  knowledge  would  be  likely  to  bring 
the  essential  idea  involved  to  someone  else  or  to 
several,  and  that  the  general  public  or  that  part 
of  the  public  using  the  invention  cannot  be  re- 
garded as  perpetually  indebted  to  the  patentee. 
May  not  the  discovering  of,  and  the  calling  of  the 
community's  attention  to,  the  value  of  new  sites 
be  a  service  of  this  limited  kind?  Can  it  be  sup- 
posed that  the  residents  of  a  city  would  forever, 
and  despite  increase  of  numbers,  be  indifferent  to 
the  advantages  of  living  in  "Hillcrest,"  "River- 
view,"  "Countryside,"  or  "Eastville"?  For  how 
many  generations  must  the  public  pay  the  descend- 
ants of,  or  the  purchasers  of  land  from,  those  who 
first  emphasized  or  advertised  the  advantages  of 
these  sections  for  the  service  of  thus  advertising 
them?  It  is,  indeed,  quite  possible  that  the  land 
speculators  who  first,  by  their  advertising,  induced 
population  to  move  into  a  new  section,  have  some- 
times performed  a  disservice  rather  than  a  service, 
by  unduly  hastening  a  movement  which  would  have 
normally  come  somewhat  later. 

Another  point  sometimes  emphasized  in  the 
case  of  patents  is  that  a  limited  period  of  special 


216        Earned  and  Unearned  Incomes. 

profit  is  enough  to  induce  the  invention  and  its 
exploitation.  It  is  unnecessary,  therefore,  to 
make  the  public  pay  this  excess  profit  forever. 
May  not  the  same  conclusion  apply  in  the  case  of  the 
service  of  landowners  in  calling  attention  to  the  ad- 
vantages of  special  sites? 

Even  if  we  should  decide  that  this  particular 
kind  of  service  was  of  no  value  and  that  we 
did  not  wish  population  or  business  location  to 
be  affected  by  the  activities  of  land  speculators, 
and  even  if,  therefore,  we  allowed  no  part  of 
the  rental  value  of  land  to  go  into  private  hands 
to  pay  for  such  services,  there  would  need  to  be 
no  fear  that  houses  and  other  structures  would 
not  be  built.  Obviously,  a  certain  intensity  of 
demand  and  willingness  to  pay  rent  for  houses,  etc., 
on  the  part  of  tenants,  would  yield  a  sufficient 
average  return  on  the  cost  of  building  to  make 
investors  willing  to  take  the  risk  of  building  in 
places  where  there  was  reasonable  probability 
of  the  use  of  the  houses,  and  this  without  any 
prospect  of  realization  of  situation  rent  as  an 
offset  to  possibilities  of  loss. 

While  we  are  on  this  general  topic,  one  point 
should  be  particularly  emphasized,  viz.,  that  fore- 
sight, purely  as  such,  deserves  nothing  whatever. 
The  man  who,  foreseeing  a  rise  in  certain  land 
values  from  a  probable  increase  in,  or  shift  of, 
population,  puts  himself  in  a  strategic  position 
to  profit  by  it,  is  not  thereby  rendering  any 
service  to  those  from  whom  he  derives  return. 
Foresight  used  to  give  a  service  may  earn  remu- 
neration.     Foresight   used   to   get    something   for 


Rent  of  Land  and  Its  Taxation         217 

nothing    seems    hardly    deserving    of    any    special 
protection. 

§  6 

The  Increment  of  Land  Values  in  Relation  to  the 
Settlement  of  the  American  West 

The  expectation  of  an  increase  of  land  values, 
considered  as  an  inducement  to  bringing  new 
land  into  use,  has  sometimes  been  brought  up  in 
connection  with  the  settlement  of  the  West.  It 
has  been  asserted,  for  example,  that  the  lure  of 
the  "unearned  increment"  was  instrumental  in 
inducing  the  settlement  of  the  West.^*  It  has 
also  been  argued,  in  the  same  connection,  that  the 
stimulus  to  settlement  of  the  West  and  its  earlier 
settlement  because  of  this  prospect  of  an  increas- 
ing value  of  the  land,  benefited  not  only  the  set- 
tlers, but  also  those  who  remained  East,  and  that, 
therefore,  the  unearned  increment  was  "diffused" 
throughout  the  country.^^  Many  have  doubtless 
drawn  from  this  contention  the  conclusion  that 
the  descendants  of  the  early  settlers  in  the 
West  are  clearly  entitled  to  any  increase  that 
may  have  come  to  the  value  of  their  land.  The 
argument  regarding  the  dift'usion  of  the  increment 
is  based  upon  the  belief  that  the  prospect  of 
rising  land  values,  by  inducing  a  movement  of 
the  labor  supply  westward  and  its  settlement  upon 
the  farms,  prevented  the  labor  congestion  in  the 

i*See  J.  B.  Clark,  The  Distribution  of  JVealih,  New  York  (Mac- 
millan),   1899,  pp-  85-87. 
^"•Ibid. 


218        Earned  and  Unearned  Incomets 

East,  in  the  cities,  and  even  in  the  agricultural 
West  from  being  as  great  as  it  might  otherwise 
have  become.  Hence,  it  can  be  argued,  the  settle- 
ment of  the  West  prevented  the  marginal  product 
of  labor  from  being  so  small  and  wages  from 
being  so  low,  in  the  East  and  elsewhere,  as  might 
otherwise    have    been    the    case. 

But  may  we  not,  in  some  degree,  question  the 
conclusion  that  an  unearned  increment,  or  any 
substantial  amount  of  it,  was  necessary  to  get 
the  West  settled?  After  all,  relatively  few  of 
the  settlers  were  fortunate  enough  to  take  up 
land  which  afterward  became  part  of  the  sites 
of  cities  and  it  is  probable  that  most  of  them 
did  not  seriously  expect  such  fortune.  May  we 
not  conclude  that,  for  the  most  part,  they  might 
have  been  willing,  for  the  possibility  of  enjoying 
homes  where  the  marginal  product  of  their  labor 
gave  promise  of  being  high  to  go  and  take  up  new 
land  even  though  the  value  of  the  bare  land,  as 
such,  could  not  be  expected  greatly  to  increase? 

If  not,  however,  if,  on  the  contrary,  the  pros- 
pect of  an  increasing  land  value  was  an  essential 
part  of  the  invitation  of  the  West,  then  the  ques- 
tion arises  whether  settlement  was  hastened,  to 
the  temporary  economic  loss  of  those  who  went 
first  and  to  the  later  loss  (through  rent  payments) 
of  those  who  followed,  and  whether  a  more  grad- 
ual spreading  of  population  westward,  when 
a  real  need  rather  than   an   artificial   inducement 


Rent  of  Land  and  Its  Taxation         219 

began  to  operate,  would   not  have  been   economi- 
cally   better.  "= 

As  to  the  question  whether  the  early  comers  or 
their  descendents  are  entitled  to  rent  compensation 
for  being  earliest  because  of  any  service  that  they 
thus  rendered,  we  must  bear  in  mind  that  any  such 
compensation,  under  our  present  land  system, 
does  not  come  from  those  easterners  whose  wages 
are  conceivably  higher  because  of  the  drawing 
off  of  surplus  population  to  the  West.  Nor  will 
it  probably  come,  for  the  most  part,  from  wage- 
earners  in  the  West  whose  wages  have  been  made 
higher  by  the  movement  to  the  land  so  stimulated 
by  the  prospect  of  securing  a  profit  from  its 
appreciation.  Under  the  present  land  system, 
the  rental  compensation  to  the  western  landowners 
comes  from  people  living  in  the  West,  and  mostly 
from  people  who  came  a  little  too  late  to  get  land 
for  themselves,  or,  in  some  cases,  from  people 
who  had  other  ambitions.  It  is  these  people 
whose  coming  and  whose  demand  for  the  use 
of  the  land  bid  up  land  rents.  To  them,  as  per- 
sons who  have  come  to  be  inhabitants  of  the 
West,  any  artificially  induced  scarcity  of  labor  in 
the  East  is  no  longer — if,  perchance,  it  once  was — 
an  advantage.  Their  wages  are  not  higher,  but 
lower,  in  the  long  run,  than  if  the  West  were 
less  completely  settled.  For  the  marginal  product 
of  western  labor  is  presumably  less.  The  old 
alternative    of   taking   up    new    and    good    land    is 


"  Cf.  Professor  H.  J.  Davenport's  article  entitled  "Theoretical  Is- 
sues in  the  Single  Tax,"  in  the  American  Economic  Revieic,  March, 
1917,  especially  pp.  22-26. 


220        Earned  and  Unearned  Incomes 

gone.  Of  course,  so  long  as  there  was  still  other 
new  and  good  land  to  be  had,  even  western  wages 
must  have  been  kept  up  by  the  rush  of  labor  to 
this  land,  but  this  would  not  continue  to  be  the 
case  as  the  land  filled  up  and  as  the  available  free 
land  became  progressively  poorer.^^ 

In  what  sense,  then,  and  how  far,  were  the 
benefits  of  rising  land  values  diffused?  Was  it  in 
such  a  sense  that  the  descendants  of  those  who 
did  not  take  up  land  must,  in  justice,  pay  the 
descendants  of  those  who  did,  for  the  privilege  of 
living  and  working  on  it?  Are  the  descendants 
of  those  who  did  not  acquire  the  land  to  be  re- 
garded as  having  so  gained  from  the  possibly 
slightly  larger  labor  incomes  of  their  grandfathers, 
or  to  have  so  lent  their  moral  sanction  to  the 
system,  as  to  be  under  obligation  not  to  change 
it,  even  where  cities  have  grown  up  and  have 
made  land  which  was  worth  its  hundreds  of  dol- 
lars now  worth  millions?  Is  it  their  social  duty 
to  go  on  paying  indefinitely  for  the  use  of  land 
which  would  be  equally  available  and  which  would 
be  about  equally  desirable  if  any  individual  owner 
to  whom  or  to  whose  descendants  the  payments 
for  its  use  are  made  had  never  lived?  Or  can 
society  in  general  be  regarded  as  having  ever 
even  impliedly  pledged  itself  that  the  increase  in 
land  values  resulting  from  social  growth  should  go 

1^  Furthermore,  the  consequent  inflow  of  new  labor  from  the 
East  and  of  immigrant  labor  into  both  East  and  West  tended,  by 
rapidly  filling  any  vacuum,  to  prevent  any  considerable  realization 
of  such  a  gain  in  wages- 


Rent  of  Land  and  Its  Taxation         221 

entirely  to  individuals  and  should  not  be  subject 
to  any  considerable  taxation  by  states  or  cities? 
Is  it  not,  indeed,  clear  that  we  are  very  definitely 
maintaining  a  land  system  which  makes  part  of 
the  public  pay  large  sums  annually  to  the  rest 
of  the  public  for  no  service  that  the  recipients 
of  these  sums,  or  their  ancestors,  or  any  other 
landowners  as  such  have  ever  rendered  to  the 
persons  from  whom  their  rental  incomes  are  de- 
rived? Why  are  those  who  thus  pay  without 
getting,  under  an  obligation  to  maintain  the  sys- 
tem and  to  continue  paying  through  all  future 
time?  Must  countless  generations  of  the  disin- 
herited be  held  under  obligation  to  pay  for  a 
somewhat  problematical  "diffusion"  benefiting  some 
of  their  ancestors,  a  diffusion  from  which  most 
of  the  descendants  of  those  who  may  thus  have 
somewhat  benefited  have  very  likely  realized 
nothing  whatever?  We  do  not  allow  the  creditors 
of  a  father  to  require  payment  for  the  father's 
debts  from  the  labor  income  of  a  son,  however 
much  the  father  may  have  gained — in  his  life- 
time— by  his  borrowing,  nor  do  we  insist  on  "com- 
pensation" to  a  creditor  who  is  therefore  unable 
to  recover.  We  adhere  to  this  policy  because  we 
do  not  consider  it  socially  desirable  to  make  one 
class  partially  the  slaves  of  another  class,  to  com- 
pel them  to  spend  part  of  their  time  working  for 
that  other  class  without  return  from  the  latter, 
even  though  the  latter  class  may  conceivably  have 
rendered  a  real  service  to  the  ancestors  of  the 
class  that  pays.  May  it  not  be  as  much  contrary 
to    good    public    policy    to    recognize    any    implied 


222        Earned  and  Unearned  Incomes 

contract  by  which,  as  an  offset  to  the  possibly 
temporarily  larger  incomes  of  one  class,  the  des- 
cendants of  that  class  have  to  pay  others  for  the 
use  of  the  earth?  Is  not  the  recognition  of  any 
such  implied  contract  equivalent  to  recognizing 
the  right  of  men  to  sell  their  children  or  their 
grandchildren  into  slavery?  We  would  not  recog- 
nize the  latter  right,  in  our  society,  directly  and 
avowedly,  even  if  the  children  were  sold  to  get 
food  to  save  their  lives.  Must  we  recognize  the 
former?  It  is  true  that,  in  the  case  of  land  rent, 
we  associate  the  payment  made  with  a  material 
thing,  the  land,  but  are  we  not,  nevertheless,  in 
essence,  dealing  with  a  payment  for  which  no 
service   is    rendered? 

Let  no  one  conclude  that  our  argument  tells  equally 
against  all  inheritance  on  the  ground  that  those 
who  pay  interest  for  the  use  of  capital  accumulated 
by  previous  generations  are  paying  for  a  service 
to  persons  who  did  not  contribute  that  service. 
For  it  well  may  be,  in  the  case  of  inheritance  of 
capital  produced  by  human  labor,  that  the  prospect 
of  descendants'  reaping  return  from  it  is  a 
condition  without  which,  in  great  part,  it  would  not 
be  saved.  If  so,  the  interest  is  paid  for  a  service 
which,  except  for  the  prospect  of  interest  pay- 
ment to  descendants,  might  never  have  been 
rendered;  it  is  paid  for  the  use  of  capital  which, 
except  for  expectation  of  reward  to  descendants, 
might  never  have  been  added  to  society's  equip- 
ment. As  long  as  the  family  affections  endure  in  their 
present  strength  much  of  the  happiness  of  parents 


Rent  of  Land  and  Its  Taxation         223 

will  be  realized  only  as  they  are  permitted  to 
work  for  the  future  prosperity  of  their  children. 
General  welfare  and  happiness  would  probably  not 
be  furthered  by  a  policy  which  should  entirely 
deprive  parents  of  the  privilege  of  bequest.  Nor 
would  the  community  probably  get,  in  the  long 
run,  the  use  of  so  much  capital,  for  less  would 
probably  be  accumulated.  A  parent  will  be  less 
likely  to  save  and  to  invest  his  earnings  in 
the  education  of  his  children  if  he  believes  so- 
ciety will  appropriate  all  the  gain  and  will  not 
allow  his  children  to  reap  a  larger  income  for 
the  larger  service  which  such  education  enables 
them  to  render.  And  in  like  manner,  a  parent 
will  be  less  inclined  to  save  and  invest  in  capital 
construction  if  he  believes  that  society  will  allow 
his  children  to  reap  no  advantage  in  return  for 
the  service  from  such  capital. 

There  is  no  intention  to  suggest,  however,  that 
inheritances  should  never  be  taxed  or  that  the 
law  of  inheritance  is  not  in  need  of  modification. 
When,  as  at  present,  the  state  provides  for  inherit- 
ance of  the  property  of  intestate  decedents  by 
remote  collaterals  who  have  often  been  unac- 
quainted with  their  unconscious  benefactors,  it  can 
hardly  be  said  that  the  policy  adopted  has  been 
dictated  by  the  necessity  of  encouraging  accumula- 
tion or  by  the  desirability  of  giving  men  and 
women  the  happiness  of  safe-guarding  the  future 
welfare  of  those  for  whom  their  affections  are 
strongest. 

But  whatever  may  be  the  advantages  to  the 
general    welfare    of    maintaining    in    considerable 


224        Earned  and  Unearned  Incomes. 

degree  the  right  of  bequest,  there  appears  to  be 
no  reason  to  believe  that  to  keep  the  major  part 
of  ground  rent  from  going  into  the  pockets  of 
individuals  w^ould  decrease  the  amount  of  land 
or   the   amount   of   any   other   capital. 

If  it  is  said  that  the  western  homesteaders 
sometimes  had  to  fight  the  Indians,  it  can  also 
be  said  that  they  frequently  and  largely  received 
protection  from  the  United  States  army  paid  for 
out  of  the  general  tax  fund;  and  it  may  v^ell  be 
that  men  who  served  in  the  army  and  gave  such 
protection,  or  men  who  contributed  in  taxes  to 
maintain  it,  afterward  came  to  have  to  pay,  for 
the  use  of  land,  persons  so  protected.  It  is  to  be 
questioned  whether  any  service  of  the  pioneers, 
still  less  of  the  droves  of  later  settlers,  who  follow- 
ed them  while  the  land  was  still  cheap,  was  so 
important  and  far-reaching  that  their  descendants 
can  be  held  to  have  acquired  a  right  to  receive 
tribute  for  all  future  time  because  of  this  service, 
and  that  the  millions  of  dollars  of  situation  rent 
in  the  cities  of  Chicago,  St.  Louis,  Denver,  Los 
Angeles,  and  San  Francisco  really  all  represent 
legitimate  payment  from  later  comers  and  their 
descendants  for  the  equivalent  services  to  these 
later  comers  and  their  descendants,  of  those  who 
chose  to  come  first.  Surely,  one  who  holds  this 
needs  take  but  a  short  step  farther  to  prove  that 
the  whole  idea  of  the  unearned  increment  is  a 
myth,  or  the  product  of  diseased  imagination,  and 
that,  really,  anything  that  anyone  gets  is  earned 
by  equivalent  service  to  the  one  who  pays  it. 


Rent  of  Land  and  Its  Taxation         225 

§   7 

Ovmership  of  Land  by  Small-Family  Groups  ver- 
sus Increasing  Population  in  Other  Groups 

A  special  phase  of  the  land  problem  arises  in 
connection  with  the  rights  of  small  holders  of 
land  whose  land  has  been  handed  down  to  them 
by  ancestors  who  have  deliberately,  when  popula- 
tion was  increasing,  kept  their  own  families  small, 
and  who  have  hoped,  thus,  to  bequeath  to  their 
children  a  sufficiency  of  land  for  the  latter's  use. 
We  may  advantageously  approach  this  problem  by 
considering  a  related  one — that  of  immigration. 
There  seems  to  be  a  growing  opinion  that  a  highly 
civilized  and  prosperous  country  having  a  low 
birth-rate  may  properly  protect  its  standards  of 
living  and  of  wages  by  excluding  from  its  shores 
the  teeming  millions  of  more  prolific  races  whose 
multiplication  reduces  them  to  poverty  at  home 
and  whose  invasions  of  other  and  happier  lands 
tends  to  make  such  poverty  world-wide.  To  let 
them  enter  may  only  make  room  for  new  millions 
in  their  native  country,  relieve  the  poverty  of  that 
country  but  slightly,  and  add  to  it  the  poverty, 
due  to  immigration,  of  the  low  birth-rate  country. 
Yet  the  latter  country,  if  it  practices  exclusion,  is 
maintaining  a  monopoly  of  its  land  for  its  relative- 
ly sparse  population,  and  is  shutting  out  from  any 
possible  use  of  this  land  the  millions  who  fain 
would  come. 

What   now   of  the   thousands   of   families   in   a 

country  who  have  each  enough  land  for  the  most 

efficient   application    of   their   own    labor   and    for 

comfortable  subsistence  and  who,  by  limitation  of 

15 


226        Earned  and  Unearned  Incomes. 

offspring,  are  preventing  the  undue  subdivision  of 
such  land  into  small  plots — who  are  doing  their 
share  in  keeping  up  the  general  level  of  comfort 
by  trying  to  prevent  too  great  an  increase  of 
population  in  relation  to  available  land?  If  the 
rest  of  the  nation  multiplies  quite  without  regard 
to  natural  resources  or  land  space  and  so  forces 
down  the  margin  of  labor  production,  does  society's 
right  to  land  space  justify  redividing  the  land 
equally,  thus  directly  depriving  the  families  which 
have  kept  down  their  numbers  of  the  standard  of 
comfort  which  would  naturally  result  from  their 
low  birth-rate?  Or  does  this  right  of  society 
justify  a  system  of  taxation  of  rental  values  which 
indirectly  accomplishes  the  same  result?  For  it 
should  be  clear  that  if  the  land  so  held  by  individ- 
ual families  comes  to  be  more  valuable,  not  by 
virtue  of  its  yielding  more,  but  solely  because 
pressure  of  population  increases  the  demand  for 
it,  then  to  take  the  greater  annual  value  in  taxa- 
tion will  leave  less  to  the  owners  than  before.  To 
express  differently  the  same  thought:  if  the  policy 
of  state  appropriation  of  land  rent  is  consistently 
applied,  so  that  individuals  get  only  the  earnings 
of  their  other  capital  and  the  wages  of  their 
labor  (employed  or  self-directed),  then  an  increase 
of  population  which  lowers  the  marginal  product 
of  labor  will  not  only  enable  the  state  to  collect 
more  than  previously  from  individual  landowners, 
but  will  leave  less  to  them  as  individuals  and 
families  than  before.  Such  an  increase  of  popula- 
tion will  leave  less  than  before  even  to  those 
families  which  are  in  no  way  responsible  for  the 


Rent  of  Land  and  Its  Taxation         227 

population  increase  from  which  flows  their  new 
family  poverty.  For  this  reason — viz.,  because  it 
would  remove  a  stimulus  to  desirable  limitation  of 
offspring,  because  it  would  penalize  the  far-seeing, 
because  it  would  give  to  families  whose  ideals  tend 
toward  universal  misery  the  inheritance  of  those 
families  whose  ideals,  if  generally  adhered  to, 
would  bring  universal  plenty — such  appropriation 
of  all  rental  values  of  land  might  not  be  a  desir- 
able social  policy.  Part  of  the  rental  value  of 
land,  even  of  agricultural  land  held  by  actual 
cultivators,  may,  perhaps,  fairly  be  taken,  but  not 
all. 

To  illustrate  the  principle  involved,  suppose  a 
piece  of  land  capable  of  supporting  a  man  and  his 
family,  a  piece  of  land  just  large  enough  to  utilize 
one  man's  time  to  the  best  advantage.  Further  labor 
than  he  could  give  would  then  be  attended  with  di- 
minishing returns.  To  make  the  illustration  quanti- 
tative, we  will  assume  that  on  this  land  the  labor  of 
one  man  will  produce  500  units  (e.  g.,  bushels  of 
wheat),  of  two  men,  900,  of  three,  1,200.  If,  at 
the  start,  the  land  is  marginal,  the  occupant  and 
owner  will  enjoy  500  units  of  labor  income.  If 
population  increased  to  such  a  point  as  to  force 
wages  for  this  grade  of  labor  to  300  or  less,  he 
could  afford  to  hire,  perhaps,  two  other  men,  since 
the  second  would  add  just  300  to  the  product;  he 
would  therefore  pay  600  in  wages  to  the  two  men, 
would  receive  300  in  labor  income  for  himself, 
and  would  have  300  left  as  rent.^^     The  owner's 

18  For  simplicity  we  are  eliminating  income  on  other  capital 
from  consideration. 


228        Earned  and  Unearned  Incomes. 

total  income  would  then  be  600.  We  could  take 
100  of  this  in  taxation  and  still  leave  the  owner's 
combined  rent  and  labor  income  at  500  which  he 
w^as  getting  as  a  labor  income,  with  no  more  total 
effort,  before.  But  if  we  take  all  of  the  rent  in 
taxation,  we  leave  him  only  his  300  labor  income, 
which  is  not  much  over  half  of  his  previous  income ; 
and  we  have  subjected  him  to  deprivation  through 
an  increase  in  population  for  which  he  was  not 
responsible  and  which  was  clearly  undesirable  from 
the  point  of  view  of  general  welfare. 

However,  in  practice  the  increase  of  land 
values  is  usually  in  large  part  an  increase  in  the 
value  of  special  sections  of  land  which  growth  of 
population  causes  to  become  more  advantageously 
situated  in  one  or  more  ways.  As  the  country 
grows,  certain  places  come  to  have  new  and  special 
advantages  as  market  centers,  as  ports,  etc.,  and 
thus  acquire  an  increased  rental  value  not  depend- 
ent on  a  lowering  of  the  margin  of  production. 
Increase  of  population  in  a  fertile,  unsettled  plain, 
containing  a  great  deal  of  land  of  approximately 
the  same  fertility,  might  not  for  many  years  lower 
the  marginal  product  of  labor.  To  be  sure,  the 
later  settlers  might  have  to  go  farther,  but  the 
more  distant  points  would  be  no  more  isolated 
than  the  first-taken  land  was  at  an  earlier  date, 
and  the  extension  of  roads  and  railroads  might 
make  then  less  so.  Rent  would  rise,  not  because 
the  margin  has  become  lower,  but  because  the 
situation  of  a  part  of  the  land  relatively  to 
markets,  population  centers,  etc.,  has  become  better. 
Still  more  clearly  does  this  fact  stand  out  when  at 


Rent  of  Land  and  Its  Taxation         229 

some  point  on  the  plain  a  city  develops,  called  into 
existence  by  the  increasing  number  of  those  whom 
its  merchants,  artisans,  etc.,  can  effectively  serve. 
Its  growth  is,  possibly,  an  advantage  even  to  the 
owners  of  marginal  land,  but  confers  a  special  ad- 
vantage on  those  whose  near-by  location  enables 
them  to  reap  exceptional  profit  from  supplying  the 
city  needs  as  to  produce.  The  growth  of  the  city 
confers  a  still  greater  advantage  on  those  whose 
land  comes  to  have  value  for  distinctly  urban  uses. 
The  occasional  settler  who  or  whose  descendant 
finds  that  his  land  is  in  the  center  of  a  thriving 
city  may  become  a  millionaire  as  a  consequence 
of  conditions  to  which  his  own  contribution  was 
negligible  if  anything  at  all.  In  this  case  and,  in 
general,  in  a  country  like  the  United  States,  land 
rent  has  probably  grown  much  more  largely  by  the 
increase  of  the  possibilities  of  special,  often  supra- 
marginal,  land,  thus  creating  a  differential  between 
it  and  marginal  land,  than  by  forcing  cultivation 
to  a  lower  margin.  In  short,  any  desire  that  we 
may  feel  to  protect  small  landholders  who  limit 
their  families  from  being  made  to  suffer  through 
the  general  increase  of  population,  need  not  prevent 
us  from  taking,  in  taxation,  most  of  the  rental 
value  of  land,  including  that  of  mines  and  power 
sites,  and  nearly  all  of  the  rental  value  flowing 
from  its  situation  of  city  land. 


230        Earned  and  Unearned  Incomes. 

§  8 

The  Bearing  of  the  Contention  that  there  may  be 

Other    Unearned    Increments    Not    Especially 

Associated  with  Land 

It  has  sometimes  been  pointed  out,  by  way  of 
objection  to  the  single-tax  proposal,  that  land  rent 
is  not  the  only  income  which  is  of  the  nature  of 
an  unearned  differential.  Sometimes  the  incomes 
of  genius  in  excess  of  what  persons  of  ordinary 
ability  can  secure  are  presented  as  an  analogous 
case.  Whatever  may  be,  in  some  respects,  the 
degree  of  likeness,  the  two  cases  certainly  are  not 
alike  in  all  respects.  Thus,  it  may  not  be  equally 
possible  to  tax  largely  and  successfully  the  incomes 
resulting  from  the  exercise  of  genius,  as  to  tax 
land  rent,  for,  in  the  case  of  the  large  incomes  of 
the  exceptionally  gifted,  the  attempt  to  tax  them 
heavily  might  conceivably  discourage  effort  and 
cause  the  former  recipients  of  these  incomes  to  be 
satisfied  with  smaller — and,  therefore,  untaxed — 
returns.  Taxation  of  the  rental  value  of  land, 
however,  if  based  upon  such  general  considerations 
as  the  evident  yield  of  neighboring  sites  and  the 
apparent  market  value  of  the  land  to  be  taxed, 
i.  e.,  if  the  tax  is  not  made  larger  because  an 
efficient  producer  or  business  man  gets  more  from 
his  land  than  others  could  get,  would  probably 
in  no  wise  affect  the  owner's  choice  of  uses  for  the 
land  or  his  intensity  of  use  of  it  or  the  efficiency 
of  his  use  of  it.  Having  a  tax  to  pay  which  was 
independent  of  his  efficiency,  he  would  be  just  as 
eager  to  earn  the  maximum  income  out  of  which 


Rent  of  Land  and  Its  Taxation         231 

to  pay  the  tax  as  he  would  be  to  earn  the  maximum 
income  if  he  were  not  taxed. 

Indeed,  the  levying  of  a  tax  upon  the  potential 
situation  rent  of  land,  whether  actually  received 
or  not,  would  discourage  the  speculative  holding  of 
land  out  of  use  and  so  would  operate  to  prevent 
the  forcing  up  of  rent  by  any  scarcity  of  available 
land  induced  by  such  speculative  holding. 

Economists  whose  social  sympathies  (of  the  in- 
fluence of  which  they  are  not  always  conscious) 
or  whose  training  by  their  former  teachers,  in- 
capacitates them  for  seeing  any  distinction  be- 
tween land  and  capital  and  predisposes  them  to 
accept  superficial  resemblances  as  a  conclusive 
defense,  are  fond  of  saying  that  other  values 
than  land  values  are  enhanced  by  social  forces. 
It  is  true  enough  that  dress  suits  are  likely  to 
have  less  salable  value  in  the  Ozark  Mountains 
than  in  the  centers  of  wealth  and  fashion  and  that 
a  twenty-story  office  building  is  worth  more  in 
New  York  City  than  in  a  country  village.  Never- 
theless, cases  of  monopoly  excepted,  it  can  hardly 
be  denied  that,  year  in  and  year  out,  produced 
goods  cannot  be  sold  anywhere  for  much  more  or 
much  less  than  the  cost  of  producing  them  in  the 
places  where  they  are  to  be  sold.  An  occasional 
dress  suit  may  have  to  be  sold  at  a  sacrifice  in 
the  Ozarks,  and  a  building  too  large  for  the  needs 
to  be  met  may  prove  to  have  been  a  mistaken 
investment  in  the  country  village.  But  as  a 
general  rule  dress  suits  will  not  be  produced  in 
or  transported  to  the  Ozarks  except  as  the  antic- 
ipated   price    covers    costs,    nor    will    skyscrapers 


232        Earned  and  Unearned  Incomes 

be  regularly  built  to  sell  for  less  than  a  return 
which  seems  reasonable  in  relation  to  building 
expenses.  And,  on  the  other  hand,  where  com- 
petition is  active  and  is  carried  on  fairly,  the 
prices  of  goods  which  have  to  be  humanly  produced 
cannot  go  much  above  costs.  Even  making  all 
possible  qualifications  for  cases  of  obsolescence  and 
for  changing  conditions  of  production,  can  anyone 
say  that  cost  is  really  an  element  of  corresponding 
significance  in  the  case  of  land  rent? 

Again,  it  may  be  said  that  there  is  possible  no 
large  remuneration,  in  a  sparsely  settled  primitive 
community,  for  the  person  gifted  with  an  ex- 
ceptional voice  or  other  highly  specialized  talent. 
But  neither  is  so  large  a  service  possible  in 
return  for  the  remuneration.  When  such  re- 
muneration is  received  it  is  in  return  for  an 
equivalent  service  rendered  by  the  person  who 
receives  it,  and  this  is  not  the  case  with  the 
situation  rent  of  land.  May  not  considerations  of 
eugenics  as  well  as  of  efficiency  in  service,  apply 
differently  to  the  proposition  to  tax  such  incomes 
than  to  the  proposition  to  tax  land  rent? 

Furthermore,  some  of  the  incomes  which  are 
often  thought  of  as  unearned  are  chance  gains  so 
offset  by  corresponding  deficiencies  of  incomes  at 
other  times,  as  to  mean  no  average  loss  to  the 
public.  If  the  failure  of  the  Argentine  wheat 
crop  may  unexpectedly  give  to  American  farmers, 
grain  dealers  and  millers  a  higher  return  than 
was  contemplated  when  they  made  their  expendi- 
tures for  seed,  labor  or  grain;  so,  i^lso,  an  un- 
expectedly   large    crop    of    wheat    in    Argentina, 


Rent  of  Land  and  Its  Taxation         233 

Canada,  or  elsewhere,  may  compel  the  same  persons 
to  accept  prices  which  fall  far  short  of  compensat- 
ing them  for  the  expenditures  and  effort  under- 
gone. The  general  public  is  likely  to  gain  in  the 
latter  case  as  much  as  it  loses  in  the  former.  But 
the  general  public  never  gains  from  an  unexpected 
fall  in  the  rental  value  of  land  except  in  the 
sense  that  the  public  is  then  less  exploited  than 
before.  It  continues  to  be  exploited,  though  in  a 
smaller  degree.  There  is  little  point  to  an  attempt 
at  equating  continuous  exploitation  varying  in 
degree,  with  occasional  excess  pay  for  service 
which  is  likely  at  other  times  to  be  underpaid. 

It  will  be  worth  while,  here,  to  emphasize  the 
fact  that  land  rent  involves  exploitation  when 
the  land  is  used  in  socially  desirable  ways  as  well 
as  when  it  is  used  anti-socially.  In  the  latter 
case,  payment  is  made  for  a  disservice.  But  even 
in  the  former  case  payment  is  made  for  a  zero 
service  or  for  a  service  less  than  equivalent  to  the 
rent.  Where  wages  of  labor,  interest  on  capital 
or  rent  on  land  are  secured  by  activities  or  by 
uses  of  property  which  definitely  injure  the 
general  well-being,  which  are  anti-social,  these 
activities  or  uses  should  be  pi'ohihited  rather  than 
that  men  should  be  allowed  thus  to  secure  wealth 
which  society  afterwards  taxes.  When  a  business 
concern  by  means  of  unfair  competition,  e.  g.  by 
misrepresentation  of  competitors'  goods  or  by 
securing   discriminating   rates    on    the    railroads,^^ 

1^  See,  for  a  fuller  discussion  along  this  line,  the  author's  Prin- 
ciples of  Commerce,  New  York  (Macmillan),  1916,  Part  III,  Chap- 
ter VII,  §  4. 


234        Earned  and  Unearned  Incomes 

succeeds  in  getting  extra  profits  which  its  rivals 
do  not  get,  or,  being  able  to  undersell  the  rivals 
discriminated  against,  gets  business  which  would 
otherwise  go  to  them,  we  have  a  clear  case  of 
unearned  income  resulting  from  anti-social  activity. 
Success  is  made  to  depend,  not  on  superior  service, 
not  on  superior  efficiency  in  economizing  labor, 
but  on  the  ability  to  exclude  rivals  from  the 
market  even  if,  as  may  well  happen,  these  rivals 
are  much  more  efficient  in  the  proper  business  of 
both  or  all.  The  public  cannot  afford  to  let  the 
principle  become  established  that  success  and 
wealth  may  be  gained  by  such  methods.  In  the 
long  run,  consumers  must  expect  to  suffer  unless 
competition  of  this  sort  is  effectively  forbidden. 
So  too,  in  the  case  of  monopoly,  which  gives 
more  than  an  ordinary  return  to  effort  or  to  the 
users  of  capital  or  land,  it  is  the  consumers  of  the 
monopolized  article  or  articles  who  are  entitled  to 
relief  since  it  is  they  alone  who  are  exploited.^" 

2"  No  opinion  is  here  expressed  regarding  the  relative  desirabil- 
ity, from  the  viewpoint  of  preventing  high  monopoly  prices  to  con- 
sumers, of  public  regulation  and  of  public  operation  of  industries 
which  have  to  be  or  ought  to  be  of  monopoly  size-  But  if  public 
operation  is  chosen,  it  would  seem,  on  the  principles  set  forth  in 
this  book,  undesirable  that  the  public  should  pay  for  the  capitalized 
value  of  the  land  rent  included  in  the  prospective  returns  of  such 
monopolies.  If  not  to  pay  for  such  capitalized  exploitation  in  cases 
where  the  public  chooses  to  take  over  the  ownership  of  any  in- 
dustries is  objectionable  as  discriminating  against  some  landowners 
while  allowing  others  to  continue  to  enjoy  site  rent,  then  the  taking 
over  of  these  industries  by  purchase  should  be  deferred  until  a  gen- 
eral policy  is  adopted  towards  all  site  rent.  Nor  should  government 
for  any  long  period  guarantee  interest  or  net  dividends  on  the 
bonds  or  stocks  of  companies  whose  property  it  undertakes  to  oper- 


Rent  of  Land  and  Its  Taxation         235 

In  general,  industrial  free-booting  should  be  stamp- 
ed out,  so  far  as  this  is  possible.  But  for  un- 
earned income  in  the  form  of  land  rent,  purely  as 
such,  the  tax  method  is  adequate  and  is  the  logical 
method  of  correction. 

Again,  even  if  there  are — as  there  may  be — 
other  increments  than  situation  rent  which  are 
equally  unearned,  it  does  not  follow  that  the 
heavier  taxation  of  land  values  should  be  deferred 
until  such  time  as  a  general  agreement  is  reached 
regarding  such  other  increments.  It  may  suit 
the  views  of  reactionaries  to  have  us  use  the 
claim  that  many  and  complicated  reforms  are 
needed,  as  a  reason  for  delaying  one  the  justice 
and  desirability  of  which  are  reasonably  evident, 
but  that  kind  of  attitude  should  scarcely  suit 
anybody  else. 

§   9 
The    Taxation    of    Future    Increments    of    Vahie 

Hesitating  to   accept  the  more  radical   proposal 
of  Henry   George   in   favor   of   sweeping   into   the 

ate.  For  suppose  that  during  the  period  of  such  a  guarantee,  one 
or  several  of  the  States,  or  the  Federal  government  itself,  should 
choose  to  adopt  a  new  tax  system,  e.  g.  to  increase  ver^'  greatly  the 
tax  on  site  values.  This  would  for  all  other  industries  than  the 
ones  in  question  diminish  the  land-rent  part  of  their  incomes,  though 
to  be  sure,  removal  of  other  taxes  might  increase  other  elements  in 
their  incomes.  But,  whatever  the  net  resvilt  on  these  other  indus- 
tries, the  holders  of  the  securities  of  the  government-operated  indus- 
tries would  experience  no  effect  as  regards  their  annual  returns.  The 
better  way  would  be  to  guarantee  (if  there  is  to  be  a  guarantee  of 
past  earnings)  previous  earnings  plus  previous  taxes  minus  future 
taxes. 


236        Earned  and  Unearned  Incomes. 

public  treasuries  situation  rent  both  new  and  old, 
some  writers  have  contented  themselves  with 
advocating  the  public  taxation  and  use  of  future 
increases  in  the  rental  value  of  land.-^  This 
advocacy,  they  seem  to  have  felt,  frees  them 
from  the  necessity  of  urging  anything  that  looks 
like  confiscation.  But  there  are  reasons  for  think- 
ing that  if  the  more  radical  proposal  involves 
confiscation,  the  other  does  also,  though  it  may 
be  less  in  degree ;  and  it  is  doubtful  if  the  more 
moderate  plan  can  be  successfully  defended  without 
raising  a  presumption  that  the  more  far-reaching 
scheme  has  also  something  in  its  favor. 

To  the  proposal  that  only  future  increases  in 
rental  value  be  taken  by  the  state,  it  has  been 
answered  that  to  take  future  increases  without  com- 
pensating landowners  in  the  case  of  future  de- 
creases in  the  value  of  their  land  unfairly  deprives 
them  of  the  chance  of  gain  while  still  leaving  them 
the  risk  of  loss.  In  the  words  of  F.  A.  Walker, 
"the  game  of  'heads  I  win,  tails  you  lose'  is  not 
one  in  which  the  state  can,  in  fairness  and  decency, 
play  a  part."--  If  one  believes  that  the  present 
rental  yield  of  land,  as  well  as  future  increases  of 
this  yield,  should  not  go  to  the  private  owner,  this 
contention  will  not  disturb  him.  Otherwise  it  may 
seem  to  be  convincing. 

There  still  remains  the  argument,  however,  that, 
in  a  growing  country  increases  are  frequent  and 

2^  See,  for  example,  Taussig,  Principles  of  Economics,  New  York 
(Macmillan),  1912,  Vol.  II,  p.  102.  This  scheme  was  suggested  by 
John  Stuart  Mill  in  the  middle  of  the  last  century. 

^^  Political  Economy,  Advanced  Course,  New  York  (Holt),  1887, 
pp.  416,  417. 


Rent  of  Land  and  Its  Taxation         237 

decreases  rare  and  that,  therefore,  no  large 
injustice  would  be  done  by  the  scheme.  But  what 
if  the  opposition  contends,  as  it  plausibly  may, 
that  the  present  owners  of  land  have,  in  many 
cases,  bought  it  at  prices  which  they  were  willing 
to  pay  only  because  of  the  prospect  of  future 
increases?  The  opposition  may  contend,  in  other 
words,  that  expected  future  yields  have  been  dis- 
counted into  the  present  price  of  the  land,  and  that, 
therefore,  to  tax  heavily  these  future  yields  will 
deprive  such  purchasers  of  an  income  they  paid 
to  receive,  and  will  depreciate  the  value  of  their 
land  below  the  price  at  which  they  bought  it. 
Some  increases,  to  be  sure,  may  come  as  unfore- 
seen luck,  but  many  must  be,  at  least  in  part, 
anticipated.  Is  a  tax  on  such  increases  any 
less  "confiscation,"  so  far  as  the  capitalized  value 
of  land  is  concerned,  than  would  be  a  moderate 
increase  in  tax  which  would  take  away  a  part  of 
the  constant  annual  rent  of  a  piece  of  land  bought 
with  no  expectation  of  a  rise,  but  bought  in  the 
belief  that  its  owner  would  be  left  undisturbed  in 
the  enjoyment  of  the  entire  rent? 

Without  now  pursuing  this  comparison  further, 
we  may  note  that  a  doctrine  according  to  which 
the  public  has  no  right  to  take  by  taxation  future 
increases  in  land  values,  increases  not  earned  by 
any  service  rendered  by  the  landowners,  must, 
logically,  be  opposed  to  other  governmental  policies 
of  which  most  of  us  are  in  favor.  Such  a 
doctrine  would  mean,  for  instance,  that  the  pur- 
chaser of  stock  in  a  company  which  contemplated 
— or   the   purchaser   of  whose   stock   foresaw   the 


238        Earned  and  Unearned  Incomes. 

likelihood  of  its  undertaking — selling  out  to,  or 
becoming  part  of,  a  monopoly  and  so  securing 
monopoly  profits,  since  such  purchaser  paid  more 
for  his  stock  because  of  this  expectation,  must  be 
allowed  to  enjoy  these  monopoly  profits,  or,  if  they 
are  taken  away  from  him,  must  be  compensated. 
Has  the  purchaser  of  stock  under  circumstances 
of  this  kind  any  such  claim  even  if  the  policy  of 
limiting  monopoly  profits  is  one  which  was  not 
previously  in  force  but  was  adopted  after  he 
purchased  the  stock? 

§  10 

Land-Value  Taxation  in  Relation  to  the  Theory  of 

Vested  Rights 

The  principal  objection  actually  felt,  if  not  the 
one  chiefly  emphasized  by  opponents  of  land-value 
taxation,  is  an  objection  based  upon  respect  for 
vested  rights,  viz.,  that  such  a  scheme  of  taxation 
would-  take  away  from  the  owners  of  land  a  large 
part  of  the  capitalized  value  of  their  property  by 
making  it  impossible  for  them  to  enjoy  from  it  the 
expected  future  income.  If  a  piece  of  land  yielding 
$1,000  per  year  is  valued  on  a  5  per  cent  basis, 
its  selling  price  would  be  $20,000.  To  take  $200  a 
year  would  mean,  since  a  tax  on  land  rent  can- 
not be  shifted,  that  the  selling  price  of  the  land 
must  fall  to  $16,000.  Hence,  it  is  said,  since 
such  taxation  takes  from  the  owner  a  fifth  of  the 
value  of  his  property,  it  is  confiscation  and  a 
denial  of  vested  rights.  Of  course  what  we  def- 
initely take  is  a  fifth  of  the  yearly  income,  but 


Rent  of  Land  and  Its  Taxation         239 

since  the  value  is  dependent  upon  the  income, 
the  establishment  of  such  a  tax  as  a  permanent 
pa7't  of  the  tax  system  in  effect  takes  one-fifth  of 
the  capital.  But  how  is  it  if  through  indirect  taxa- 
tion we  take  $100  a  year  from  the  family  of  a 
workingman  whose  annual  income  is  $500.  If 
the  man's  expectation  of  life  is  thirty  years, 
would  not  the  capitalized  value  of  his  income  be 
well  in  the  thousands  of  dollars,  supposing  it  to 
be  salable?  And  would  not  this  capitalized  value 
be  reduced  one-fifth  by  a  tax  of  $100  per  year  if 
such  a  tax  were  adopted  as  a  permanent  part  of 
the  tax  system?  To  be  sure,  workmen  are  not  in 
the  habit  of  thus  capitalizing  and  selling  the 
right  to  their  future  incomes,  but  is  the  injury  to 
them  from  a  tax  any  the  less  for  that,  or  the  funda- 
mental nature  of  the  problem  essentially  different? 
If  a  need  of  increased  revenues  were  thus  met, 
there  might  be  sympathy  expressed  for  the  working 
classes  and  objection  to  the  tax  as  an  undue 
hardship  upon  them,  but  the  word  "confiscation" 
or  the  expression  "vested  rights"  probably  would 
not  be  used.  No  complaint  would  be  made  that 
the  fundamental  rights  of  property  were  being 
invaded  or  that  society  had  violated  any  implied 
pledge. 

It  seems  to  be  this  last  motion,  that  of  an  implied 
pledge  or  sanction  given  by  society,  which  makes 
many  thinkers  regard  so  askance  any  proposal  for 
radical  changes.  We  must  not  take  rent  in  taxation 
because  the  enjoyment  of  it  is  a  vested  right. 
"Society"  has  allowed  individuals  to  appropriate 
nearly  all  of  rent  in  the  past  and  various  persons 


240        Earned  and  Unearned  Incomes. 

have  bought  land,  relying  upon  the  continuance 
of  the  system.  Hence  the  private  enjoyment  of  land 
rent  must  always  be  allowed  unless  compensation 
is  paid  by  the  dispossessed  to  the  possessors. 

If  we  are  perfectly  frank  in  our  adoption  of 
this  vested-rights  argument  as  a  reason  for  re- 
fusing to  take  from  those  enjoying  them  incomes 
not  earned  by  service  given  to  those  who  pay  them, 
we  shall  have  to  admit  very  frankly  that  several 
types  of  income  ordinarily  objected  to  by  econo- 
mists must  be  continued  indefinitely.  Thus,  in 
consistency,  we  must  protest  against  any  regula- 
tion of  monopoly  which  will  do  away  with  the 
monopoly  prices  on  which  any  monopolists  had 
counted,  and  particularly  so  if  the  monopolists  have 
bought  stock  at  a  higher  price  because  of  the  ex- 
pectation of  monopoly  profit.  "Society"  has  per- 
mitted this  profit  in  the  past,  has  lent  its  "sanc- 
tion" to  it,  has  allowed  people  to  buy  stock  in  the 
expectation  of  realizing  an  exceptional  profit.  May 
society,  therefore,  by  its  regulations  cut  down  this 
profit?  Must  it  not  pay  the  monopoly  prices  in- 
definitely or  else  compensate  the  monopolists  by 
paying  them  in  advance  the  capitalized  value  of 
their  expected  future  monopoly  profits? 

So,  again,  if  we  would  be  perfectly  consistent, 
we  must  not  remove  the  protective  tariff  on  goods 
when  those  who  have  invested  in  the  companies 
producing  such  goods  have  paid  more  for  their 
stock  than  they  would  otherwise,  in  the  expecta- 
tion of  deriving  protected  profits.  In  other  words, 
since,  largely  through  the  influence  of  those 
engaged    in    protected    industries,    the    policy    of 


Rent  of  Land  and  Its  Taxation         241 

protection  has  been  maintained  for  a  limited 
number  of  years,  society  at  large  owes  such 
industries  a  continuance  of  favor.  In  still  other 
words — for  this  is  the  inescapable  implication — 
those  who  wish  to  consume  the  protected  goods 
may  properly  be  required  to  pay  for  these  goods 
an  excess  price,  a  price  above  the  real  value  of 
the  service  given.  In  this  view  of  the  case,  the 
taxed  class,  being  part  of  society,  has  some  sort 
of  responsibility  for  what  society  has  done,  even 
for  what  the  class  that  profits  by  protection  has 
influenced  society  to  do,  and  has  no  right  suddenly 
to  refuse  longer  to  pay  tribute  to  the  protected 
class. 

The  foregoing  is  a  view  which  the  writer  cannot 
bring  himself  to  accept.  Society  is  under  no  obli- 
gation nor  is  any  class  in  society  under  an  obliga- 
tion to  pay  tribute  to  any  person  or  group  of 
persons  for  all  future  time.  Still  less  is  a  class 
which,  ivhile  another  class  has  controlled  govern- 
ment, has  been  exploited,  under  obligation  to  con- 
tinue to  let  itself  be  exploited  if  and  when  it  is 
able  to  get  into  the  saddle.  Society  as  such  has 
given  no  pledge,  and  is  not  in  a  position  to  give 
a  pledge,  that  its  policy  will  not  change.  Those 
who  buy  stock  in  a  monopoly  or  invest  their 
money  in  a  protected  industry  must  be  held  to 
have  done  so,  not  under  any  guaranty  of  perma- 
nence, but  at  their  own  risk,  knowing  it  to  be  the 
right  of  the  rest  of  society  to  cease  paying  the 
excess  prices  and  adopt  a  new  policy  at  any  time. 

How  does  the  matter  stand  in  the  case  of  land 
values?     Is  it  correct  to  think  of  land-value  taxa- 


242        Earned  and  Unearned  Incomes. 

tion  primarily  as  a  system  of  taxation  that  in- 
fringes on  vested  rights  by  taking  something  away 
from  landowners?  Is  it  not  more  enlightening  to 
call  to  mind  that,  indeed,  the  rest  of  society  is 
continually  (weekly,  monthly,  or  annually)  ^'^  pay- 
ing tribute  to  the  owners  of  land,  tribute  for  which 
neither  these  owners  nor  any  previous  owners  as 
such  have  ever  rendered  a  return  to  those  who 
thus  pay  them?  When  we  say  that  for  the  public 
to  take  in  taxation  most  of  the  rental  value  of 
land  would  be  to  confiscate  the  "property"  of  those 
who  had  previously  enjoyed  this  rent,  do  we  not 
express  the  fact  the  wrong  way  about?  Would 
it  not  be  nearer  the  truth  to  say  that  the  rest  of 
society  simply  refuses  longer  to  have  its  earnings 
confiscated  by  the  landowning  class?  Does  the 
situation  value  of  land,  the  value  apart  from  im- 
provements, represent  anything  else  but  the  esti- 
mate, in  a  present  valuation,  of  the  future  tribute, 
the  future  payments  without  corresponding  serv- 
ices, which  the  owners  are  in  a  position  to  get 
from  others?  Are  not  the  masses  paying  a 
perpetual  tax  to  the  owners  of  land  for  the 
privilege  of  living  upon,  and  making  use  of,  sites 
which  were  neither  produced  nor  rendered  valuable 
by  the  owners?  Suppose  the  masses  who  are  thus 
paying  tribute  without  receiving  either  labor 
services  or  more  capital  equipment  for  production 
than  would  otherwise  be  available,  or  indeed  any- 
thing else  worth  the  price,  simply  decide  to  stop 

23  Cf.  Henry  George,  Progress  and  Poverty,  Book  VII,  Chapter 
III,  particularly  pp.  362  and  363.  (Page  reference  is  to  edition  of 
1905,  Doubleday,  Page  &  Co.) 


Rent  of  Land  and  Its  Taxation         243 

paying  this  tribute!  Would  their  doing  this  be 
confiscatory?  And  must  they,  if  they  are  to 
cease  paying,  compensate  the  landowners  by  giving 
to  the  latter  interest-bearing  bonds  worth  as 
much  as  the  land,  and  payable  finally,  as  to  interest 
and  principal,  by  the  same  persons  who  now  pay 
rent?  Is  this  not  equivalent  to  saying,  not  only 
that  those  who  are  slaves  in  the  sense  that  they 
devote  much  of  their  labor  to  the  support  of  a 
parasitic  class  cannot  be  freed  without  provision 
for  compensating  the  parasitic  class,  but  also  that 
the  compensation  must  be  provided  by  the  slaves? 
Could  we  reasonably  expect  the  slaves,  once  they 
were  in  the  saddle  politically  and  thoroughly  under- 
stood the  matter,  to  take  this  view  of  it? 

As  an  analogy  to  the  payment  of  tribute  for  the 
use  of  land  to  persons  who  are  in  no  way  responsi- 
ble for  its  existence,  let  us  suppose  that  an 
ancient  king  or  a  small  ruling  caste  has  some- 
where given  to  a  favorite  or  to  someone  of 
political  influence  the  negotiable  privilege  of  collect- 
ing each  year  a  certain  amount  of  the  taxes  and 
turning  them  to  his  own  use.  The  favorite  later 
sells  his  "right"  to  another  for  a  large  sum  of 
money  which  that  other  had  honestly  earned  by 
hard  and  faithful  work  at  a  useful  task.  Some 
time  after  this  second  arrangement  is  made,  the 
taxed  class  overthrows  the  power  of  the  king  or 
aristocracy  and  establishes  itself  in  power.  Must 
this  class  go  on  contributing  the  tax  because  the 
would-be  recipient  paid  to  get  it,  notwithstanding 
he  paid  nothing  to  those  whom  he  now  expects  to 
pay  him?     And  if  they  refuse,  using  the  money  in 


244        Earned  and  Unearned  Incomes 

question  instead  as  part  of  their  general  tax  fund 
for  common  purposes,  are  they  guilty  of  an  im- 
moral act?  Must  not  the  would-be  collector  of 
tax  money  be  assumed  to  have  made  his  purchase 
subject  to  the  condition  that  society  could  in  its 
own  good  time  make  such  changes  as  its  members 
might  see  fit?  And  if  the  remainder  of  society 
came  to  believe  that,  in  the  long  run,  the  greatest 
good  to  the  greater  number  would  be  attained  by 
establishing  a  system  in  which,  in  general,  each 
should  profit  according  as  he  served,  and  in  which, 
except  as  some  special  social  reason  justified  the 
apparent  exception,  no  one  might  receive  tribute 
from  those  he  did  not  serve,  would  not  society 
have  a  moral  right  to  establish  such  a  system? 

§  11 
A  Few  Additional  Considerations 

The  truth  is  that  few  of  those  who  advocate 
large  taxation  of  land  values,  even  of  the  single- 
taxers,  urge  any  but  a  gradual  change  in  the 
rate  of  taxation  of  land.  A  sudden  break  with  the 
past  is  not  sought  for.  Nor,  if  it  were,  would 
there  be  any  serious  likelihood  of  its  coming. 
Though  we  may  work  for  the  change  with  ardor,  it 
will  come  through  compromises  and  little  by  little 
and,  probably,  through  state  and  local  action. 

Even  if,  here  and  there,  a  town  or  city  increases 
rapidly  the  amount  of  tax  it  puts  upon  land,  this 
may  not,  while  the  new  system  is  not  general, 
cause  very  considerable  loss  to  landlords.  For 
it  will  be  likely  to  mean  that  in  those  cities 
businesses   and   individuals   are   relieved   of  other 


Rent  of  Land  and  Its  Taxation         245 

taxation  which  elsewhere  they  have  to  meet,  and 
the  policy  will,  therefore,  probably  cause  these 
towns  to  be  more  rapidly  settled  and  land  rents 
in  them  to  go  up.'*  This  is  a  result  which  would 
not  be  brought  about  if  the  equally  rapid  increase 
of  land-value  taxation  in  other  places  kept  the 
balance.^^ 

Furthermore,  even  if  the  tax  were  generally 
applied,  no  great  loss  would  fall  on  small  land- 
owners who  have  improved  their  land  and  who 
themselves  live  on  it,  persons  who  own  their  own 
homes  and  little  else,  since  to  them  it  makes 
relatively  little  difference  whether  the  principal 
tax  is  on  buildings  or  on  land.-°  But  to  persons 
owning  land  and  buildings  which  are  used  by 
others  or  for  the  production  of  goods  to  be  sold 
to  others,  it  may  make  a  considerable  difference, 
since  the  tax  on  land  clearly  cannot  be  shifted 
(if  general),  while  the  tax  on  buildings  very 
possibly  can  be,  at  least  to  some  extent.-' 

24  Suggested  by  Professor  H.  J-  Davenport's  Exercises,  printed 
to  be  used  with  his  Economics  of  Enterprise.  Cf.  pp.  28  and  29 
of  Professor  Davenport's  article  in  the  American  Economic  Review, 
March,   1917. 

25  Some  may  regard  it  as  an  objection  to  a  purely  local  applica- 
tion of  anything  approaching  the  single  tax  and  the  local  use  of  the 
funds  derived  from  it,  that  such  a  policy  gives  to  labor  in  the  town 
adopting  it  a  benefit  more  than  it  receives  elsewhere  and  therefore 
induces  labor  to  come  to  such  a  city  when  otherwise  it  would  stay 
awav,  and,  by  inducing  surplus  labor  to  come,  brings  diminution  of 
the  product  of  this  particular  labor. 

26  Cf.  Henry  George,  Progress  and  Poverty.  Book  IX,  chap.  iii. 

27  Whether  a  tax  on  all  the  earnings  of  capital  regardless  of 
the  line  of  investment  could  be  shifted  and  to  what  extent,  would 
depend  on  whether  and  how  far  such  a  tax  diminished  saving.     See 


246        Earned  and  Unearned  Incomes 

The  removal  of  taxation  from  all  capital  and 
its  concentration  on  land  values  would  of  course 
involve  an  increased  burden  to  those  whose 
property  was  chiefly  in  land  values.  But  the 
immediate  loss  to  the  person  who  owned  both 
land  and  capital  would  be  minimized  by  the  fact 
that  he  would  be  enjoying  relief  from  taxation  on 
his  capital-*  (the  interest  from  which,  if  the 
capital  was  being  used  in  socially  advantageous 
ways,  would  be  earned),  at  the  same  time  that  he 
was  being  made  to  pay  heavier  taxes  on  his  land 
(the  situation  rent  of  which  was  principally  un- 
earned). In  the  end,  the  removal  of  taxation  on 
capital  would  presumably  reduce  interest  rates  if 
the  leaving  of  larger  net  returns  to  owners  of 
capital  operated  to  encourage  capital  accumulation. 
But  for  some  time  the  average  property  owner 
would  probably  be  largely  compensated  in  his 
greater  net  interest  on  capital,  for  the  reduction 
by    taxation    of   his    net    rent    on    land. 

In  truth,  when  all  is  said  regarding  confiscation, 
we  must  recall  that  government  cannot  possibly 
raise  revenue  without  taking  something  from  some- 
body. And  if  we  have  to  choose  between  taking  an 
unearned  income  already  being  collected  by  part 
of  us  from  the  rest  of  us,  or  allowing  part  of 
us  to  enjoy  such  an  unearned  income  and  taking 

the  discussion  of  the  effect  of  interest  on   saving,   in   Chapter   III, 
§  5  (last  three  paragraphs  of  section). 

28  If  the  shift  in  taxation  from  capital  to  land  were  great  and 
sudden,  therefore,  the  rate  of  interest  would  be  temporarily  higher 
and  whatever  was  left  to  landowners  of  site  rent  would  have  to  be 
capitalized,  for  a  while,  at  this  higher  rate. 


Rent  of  Land  and  Its  Taxation         247 

something  more,  in  taxes  for  common  purposes, 
from  the  rest  of  us,  the  choice  should  not  be 
difficult. 

Nor  should  we  be  turned  back  by  the  contention 
that  the  proposal  so  to  raise  much  or  most  of  the 
public  revenues,  at  least  for  local  and,  perhaps, 
State  purposes,  does  not  conform  to  the  ability 
theory  of  taxation.  It  has  never  been  finally  es- 
tablished that  taxation  ought  to  be  in  proportion 
to  ability.  Taxation  ought  to  be  arranged  with  a 
view  to  societal  welfare,  and  this  may  or  may  not 
mean  that  it  should  be  in  proportion  to  ability.  So- 
cietal welfare  may  be  better  furthered,  for  in- 
stance, by  preventing  exploitation  and  the  conse- 
quent receipt  of  unearned  income,  than  by  mathe- 
matical precision  in  apportioning  taxes  to  total 
income  of  all  sorts.  The  ability  theory  of  taxation 
rests  upon  much  the  same  ground  as  the  theory  of 
charitable  relief.  In  the  case  of  charitable  relief 
it  is  argued  that  the  sums  thus  expended  have  a 
greater  (marginal)  utility  to  the  poor  and  helpless 
who  receive  them  than  to  the  relatively  prosperous 
who  contribute  them  (voluntarily  or  otherwise). 
In  the  case  of  taxation  it  is  argued  that  a  large  req- 
uisition from  one  who  is  prosperous  may  involve 
less  deprivation  and  sacrifice  than  a  small  requisi- 
tion from  one  who  is  comparatively  poor,  or,  other- 
wise expressing  the  same  idea,  that  to  take  money 
from  the  well-to-do,  even  though  they  have  fairly 
earned  it  by  giving  equivalent  service,  and  to  ex- 
pend it  for  public  purposes  so  that  a  large  part  of 
the  benefits  from  its  expenditure  is  received  by  the 
relatively  poor,  will  increase  utility  and  will  in- 
crease   the    sum    total    of    happiness.      Assuming 


248        Earned  and  Unearned  Incomes. 

wants  to  be  equal,  one  might  with  some  plausibility 
argue  that  the  maximum  of  aggregate  human  hap- 
piness could  only  be  attained  by  carrying  this  prin- 
ciple to  the  point  of  equalization  of  incomes.     But 
long  before  incomes  had  been  equalized  the  effects 
on  efficiency  of  labor,  perhaps,  also,  on  the  rate  of 
accumulation,  and,  possibly,  on  biological  selection, 
resulting  from  neglect  of  the  principle  of  making 
incomes    received    depend    on    services    rendered, 
would  become  serious.  The  greatest  welfare  would 
not  be  thus  secured,  in  the  long  nin.    If,  therefore, 
we  venture  to  m.ake  some  partial  application,  in 
our  tax  system,  of  the  principle  of  equalizing  in- 
comes, we  must  sharply  limit  our  application  of  this 
principle  in  the  taxation  of  earned  incomes  lest  we 
depart  too  far  from  the  principle  of  proportion- 
ing incomes   received  to   services   rendered.     But 
whether  or  not  there  are  classes  which,  because  of 
their  poverty,  ought  to  receive  from  the  community 
in  personal  incomes  and  in  services  from  govern- 
ment,   more   than    they   contribute,    in   taxes    and 
otherwise,  to  the  community,  it  seems  quite  certain 
that  the  recipients  of  situation  rent,  as  a  whole,  do 
not  constitute  such  a  class.     If  among  them,   are 
found  the  ubiquitous  "widows  and  orphans"  whose 
anticipated    distressful    state   has   been    made   the 
basis  of  opposition   to   many  other   necessary  re- 
forms, it  is  better  that  society  should  make  special 
provision  for  them  in  those  exceptional  cases  where 
the  shifting  of  the  tax  burden  from  other  values  to 
site  values  threatens  them  with  poverty,  than  that 
it  should  forever  maintain  a  bad  system.     Indeed 
there  must  be  many  widows  and  orphans  who  are 


Rent  of  Land  and  Its  Taxation         249 

the  victims  of  this  system,  of  which  some  of  their 
class   may  be  the  beneficiaries. 

Finally,  high  taxation  of  land  values  cannot  be 
discredited  by  referring  to  its  propaganda  as  an 
outgrowth  of  doctrines  of  "natural  rights"  while 
at  the  same  time  unconsciously  appealing  to  what 
seem  to  be  assumed  "natural  rights  of  property." 
On  the  whole,  the  supporters  of  high  land-value 
taxation  seem  to  have  been  as  consistent  as  their 
opponents  in  making  their  appeal  to  utilitarianism. 

There  is  here,  it  should  be  noted,  no  attempt  to 
argue  that  the  tax  on  land  rent  should  necessarily 
be  a  single  tax.  A  tax  which  would  take  the  great- 
er part  of  site  rent  might  or  might  not  provide 
sufficient  revenue  to  meet  the  legitimate  expenses 
of  government.  It  would  perhaps  provide  all  the 
funds  needed  for  local  and  State  governments  and 
possibly,  also,  for  ordinary  Federal  expenditures. 
But  until  permanent  world  peace  is  established, 
the  Federal  government  needs  a  source  or  sources 
of  revenue  capable  of  great  emergency  expansion, 
such  as  is  provided  in  the  income  tax  and  other 
Federal  taxes.  Extended  discussion  of  the  merits 
or  demerits  of  these  taxes,  however,  lies  outside 
the  scope  of  this  book. 

§  12 

Summanj 

At  the  beginning  of  this  chapter  it  was  shown 
that  land  rent  is  fixed  by  the  marginal  productivity 
of  land  and  is  a  surplus  over  the  interest  to  waiting 
and  the  wages  of  labor,  a  surplus  the  amount  of 


250        Earned  and  Unearned  Incomes. 

which  cannot  be  increased  by  the  owners  of  land 
to  make  up  for  the  taking  by  taxation  of  any  per 
cent  of  it.  The  attempt  was  then  made  to  dis- 
tinguish briefly  between  rent  of  land  and  interest 
on  other  capital.  The  situation  rent  of  land  we 
found  to  be  an  absolute  amount,  not  determined  by 
the  value  of  the  land  or  by  its  cost  of  production, 
but  an  essential  element  in  the  determination  of  the 
value  of  the  land.  The  value  of  reproducible 
capital,  however,  was  found  to  be  directly  deter- 
mined, in  large  part,  by  cost  of  production,  analyz- 
able  into  alternative  returns  of  the  productive 
factors  used.  The  productivity  of  capital  appeared 
to  be  an  important  influence,  perhaps  the  most 
important  direct-acting  influence,  fixing  the  rate  of 
interest.  It  further  appeared  that  the  interest  on 
capital,  when  this  capital  is  produced  and  saved 
by  eff"ort  and  waiting  respectively,  and  when  it  is 
used  in  socially  desirable  ways,  is  earned.  The 
interest  is  earned  in  the  sense  that  the  effort  and 
waiting  done  by  the  producer  and  saver  of  the 
capital  secure  for  the  community  as  much  of 
wealth  as  the  capitalist  receives  in  interest.  On 
the  other  hand,  the  situation  rent  of  land  appeared 
to  be  a  pajinent  for  benefits  due  to  natural  condi- 
tions or  to  social  growth  and  not  for  services 
brought  into  existence  by  the  owner  of  the  land. 
Thus,  the  rest  of  the  community  is  perpetually 
under  taxation  to  support  a  class  of  landowners 
from  whom,  as  such,  no  equivalent  return  is 
received.  The  landowner  who  has  bought  his 
land,  though  he  has  given  an  equivalent  for  it 
in  value  of  something  else,  nevertheless  cannot  be 


Rent  of  Land  and  Its  Taxation         251 

said  to  give  a  service  to  those  from  whom  he 
derives  rent,  which  would  not  equally  have  been 
available  had  neither  he  nor  any  other  landowner 
ever  lived.  Hence  the  private  receipt  of  rent 
violates  the  utilitarian  principle  that  each  should 
receive  remuneration  or  income  only  in  proportion 
to  service  rendered  to  those  by  whom  the  remuner- 
ation or  income  is  paid. 

In  the  course  of  our  study,  however,  it  became 
necessary  to  make  certain  qualifications  and  to 
meet  certain  criticisms.  The  rent  of  land  is  clearly 
not  all  an  unearned  income.  Part  of  it  is  interest 
on  the  cost  of  street-cutting,  paving,  etc.,  usually 
met  in  whole  or  in  part  by  special  assessments  on 
owners  of  contiguous  land.  Since  these  owners  of 
land  chiefly  benefit  through  a  resultant  increase 
in  the  rental  and  salable  value  of  their  land,  it 
seems  just  that  they  should  bear  special  assess- 
ments. But  the  justification  of  their  having  to  pay 
these  special  assessments  depends  upon  their  being 
allowed  to  receive,  in  higher  rental  value  of  their 
land,  a  return  on  the  cost  of  the  assessments.  Vari- 
ous alleged  services  of  city  landowners,  such  as 
exercising  control  over  the  class  of  tenants  in  any 
locality,  or  seeking  out,  developing,  and  advertising 
new  sites,  were  next  considered.  The  first  did  not 
seem  to  be  a  service  for  which  we  are  necessarily 
dependent  on  landowners  or,  in  any  case,  a  service 
so  costly  to  them  in  effort  as  to  justify  very  much 
of  rent.  The  seeking  and  advertising  of  new  sites 
and  bringing  them  into  use  at  an  earlier  date  than 
their  advantages  would  otherwise  be  realized  may 
sometimes  be  a  service  to  the  present  generation, 
but  is  not  clearly  a   service  to   later  generations 


252        Earned  and  Unearned  Incomes. 

who  would  eventually,  with  growth  of  population, 
have  taken  up  this  land  anyway.  Hence,  if  this 
is  a  service  justifying  rent  payment,  it  can  justify 
such  payment  only  for  a  limited  time.  It  is  like 
the  service  of  an  inventor  who  gives  us,  somewhat 
sooner  than  we  might  else  have  it,  the  benefit 
of  a  new  idea  in  mechanics,  and  to  whom  we  give 
a  definitely  terminable  right  to  receive  royalties. 
So,  also,  we  were  unable  to  conclude  that  the  early 
settlers  in  the  American  West  had  rendered  any 
such  economic  services  as  to  entitle  their  descend- 
ants and  successors  to  receive  rent  for  all  future 
time  from  the  descendants  of  later  comers.  For 
there  seemed  no  clear  indication  that  any  benefit 
was  received  or  is  being  received  by  the  later 
comers  or  their  descendants,  from  either  the  present 
or  the  former  owners  of  the  land.  If  the  "benefit" 
of  rising  land  values  was  "diffused"  in  any  sense, 
the  diffusion  was  not  clearly  to  those  of  the  present 
generation  who  now  have  to  pay  rent  to  use  the 
land.  They  may  well  regard  themselves,  if  they 
choose  to  recognize  the  authority  in  the  matter  of 
those  who  did  it,  as  "sold  out"  by  a  previous  genera- 
tion. 

Nevertheless  we  concluded  that  increased  value  of 
land  resulting  from  increasing  population  which 
forced  down  the  margin  of  production  ought  not  to 
be  made  an  excuse  for  so  taxing  land  rent  as  to 
leave  with  smaller  incomes  than  before  families 
which,  to  avoid  overcrowding  their  own  land,  had 
refrained  from  rapid  multiplication.  The  increase 
of  those  whose  habits  or  ideals  would  eventually 
tend  toward  general  misery  ought  not  to  result  in 
so  reducing  the  available  space  for  cultivation  or 


Rent  of  Land  and  Its  Taxation         253 

in  so  increasing  the  tax  on  the  land  owned  as  to 
reduce  greatly  the  incomes  of  a  non-parasitic  class 
with  ideals  of  a  different  sort.  This  last  considera- 
tion, however,  seemed  to  tell  with  but  little  force 
against  the  high  taxation  of  city  land,  since  the 
value  of  such  land  is  due  mainly  to  increase  of 
its  special  advantages  rather  than  to  a  lowering  of 
the  grade  of  land  at  the  margin  of  production. 

The  argument  that  taxation  of  land  values 
should  not  be  much  emphasized  because  there  are 
other  differential  and  unearned  incomes,  we  con- 
cluded has  little  force.  Most  other  unearned  in- 
comes, such  as  those  secured  by  monopoly  and  by 
industrial  free-booting,  require  to  be  terminated, 
rather  than  to  be  continued  in  order  that  their  re- 
cipient may  be  taxed.  If  there  are  other  incomes 
of  an  analogous  sort  to  land  rent,  the  possibilities 
of  taking  them  in  taxation  and  the  social  utility  of 
taking  them  should  be  separately  considered.  And 
in  the  meanwhile,  the  possibility  of  there  being 
other  unearned  incomes  is  no  more  an  adequate  ob- 
jection to  taxing  a  kind  of  incomes  we  know  to  be 
unearned,  than  is  the  possibility  of  there  being 
gentler  ways  of  stealing,  a  reason  why  we  should 
allow  highway  robbery  to  go  on  until  we  have 
reached  an  agreement  about  the  proper  way  to 
deal  with  all  forms  of  dishonesty.  Let  us  not  be  too 
afraid  of  a  transition  period  when  we  may  some- 
what discriminate  between  different  sorts  of  un- 
earned   incomes. 

To  avoid  the  objection  of  infringement  on 
"vested  rights,"  some  advocates  of  land-value  tax- 
ation   have    proposed    that    only    future    increases 


254        Earned  and  Unearned  Incomes. 

in  the  value  of  land  should  be  specially  taxed.    But 
this  proposal  seems  to  i^ore  the  fact  that  pur- 
chasers often  pay  a  higher  price  for  land  in  the 
expectation  of  these  very  future  increases.     How 
then,   can   special   taxation   of  these   increases   be 
anything   else    than    an    infringement   of    "vested 
rights"?     In  truth,  however,  too  great  a  respect 
for  the  "vested  rights"  of  individuals  comes  peril- 
ously near  to  meaning  no  rights  for  society.     It 
might  be  interpreted  to  mean   that  society  could 
never  modify  any  policy  in  the  expectation  of  the 
continuance  of  which  individuals  had  acted,  with- 
out giving  compensation.     It  might  be  interpreted 
to  mean  that  when  we  undertake  to  regulate  mo- 
nopoly price,  we  must  compensate  the  purchasers  of 
monopoly  stock,  and  that  when  we  choose  to  remove 
tariff  protection   we  must  compensate   holders   of 
the  stock  of  protected  industries.     If  society  is  not 
bound  to  do  these  things,  neither  is  it  bound  to  go 
on,  through  all  future  time,  paying  landowners  for 
services    which   not   they   but   nature   and    society 
render.     It  may  be  desirable — as  it  is  certainly  al- 
together   likely — that    any    great    change    should 
be  made  gradually,  but  that  society,  or  the  non- 
landowning  part  of  society,  because  it  has  paid  in 
the  past  for  no  service  received,  must  either  go  on 
doing  so  forever  or  must  buy  itself  free  with  no 
expense  or  loss  to  landowners,  is  a  doctrine  which 
even  those  who  favor  it  prefer  not  to  state,  and 
doubtless  will  not  now  state,  in  all  its  bareness. 


INDEX 


Abstinence,  saving  or,  in  rela- 
tion to  interest,  96-107. 

Accumulation,  of  capital,  78,  79 ; 
versus  marginal  capital  pro- 
ductiveness, 89-96. 

Advertising,  as  roundabout  pro- 
duction, 163,  164. 

Anderson,  B.  M.,  Jr.,  opinion  of, 
on  quantity  theory  of  money, 
criticized,   35-6n. 

Assessments,  on  landowners,  in 
relation  to  their  right  to  a 
rental    return,    209-212. 

B 

Bank  deposits,  nature  of,  38,  39; 
reserves,  change  of,  in  rela- 
tion to  interest   rates,  147^152. 

Banking,  commercial,  relation  of, 
to  the  general  level  of  prices, 
38-42. 

Birth  control,  potential  influ- 
ence of,  on  wages,  186-191- 

Bohm-Bawerk,  criticism  by,  of 
Marshall,  criticized,  103  n; 
criticism  of,  by  Clark,  criti- 
cized, 94-5  n  ;  criticism  of,  by 
Fisher,  criticized,  122,  123 ; 
misinterpretation  by,  of  Car- 
ver, noted,  102  n  ;  referred  to 
as  having  presented  influences 
retarding  accumulation,  79n ; 
tables  of,  illustrating  advan- 
tage of  roundabout  produc- 
tion, criticized,  123-4  n;  ^^'^ 
Positive  Theory  of  Capital, 
cited,  81,  117,  122,  123;  Posi- 
tive Theorie  des  Kapitales, 
Dritte  Auflage,  cited,  119,  122, 

123,     141; 

Brown,  Principles  of  Commerce, 
cited,  61  n,  73,  150,  183,  197, 
202,   233. 


Capital,     the     accumulation     of, 
78,  79 ;     accvunulation  of,  ver 


(255) 


sus  marginal  capital  produc- 
tiveness, 89-96;  cost  of  pro- 
duction of,  in  relation  to,  70; 
productivity  of,  79-88. 
Carver,  misinterpretation  of,  by 
Bohm-Bawerk,  noted,  102  n ; 
use  of  terms  "demand"  and 
"supply"  in  relation  to  inter- 
est, cited  and  criticized,  136; 
The  Distribution  of  Wealth, 
cited,  81,  102,  175-6  n. 

Cassell,  opinion  of,  regarding  di- 
minishing returns  to  capital  in 
relation  to  law  of  diminishing 
returns  on  land,  criticized,  91- 
2n;  use  of  terms  "demand" 
and  "supply"  in  relation  to  in- 
terest, criticized,  136;  The 
Nature  and  Necessity  of  In- 
terest, cited,   104,  116,   135. 

Clark,  criticism  by,  of  Bohm- 
Bawerk,  regarding  effect  of 
lenthening  the  production  peri- 
od, criticized,  94-5  n;  The 
Distribution  of  Wealth,  cited, 
15,  92,  217. 

Cost,  of  production,  influences  de- 
mand for  goods  as  well  as 
supply,  54,  55;  influence  of, 
on  supply,  59-61 ;  labor  costs, 
62-66;  land  and  capital 
costs,  66-70 ;  land  has  no  cost 
of  production,  56,  57. 


Davenport,  view  of,  regarding 
possibility  of  general  oversup- 
ply,  discussed,  49-50  n ;  Eco- 
nomics of  Enterprise,  cited,  61, 
98  n,  205 ;  Exercises,  cited, 
245 ;  "Theoretical  Issues  in 
the  Single  Tax,"  cited,  219. 

Demand,  and  supply,  in  relation 
to  price,  16-28;  definition  of, 
17,  18;  for  labor,  172-178; 
for  other  goods   in   relation  to 


256 


Index 


the  supply  of  one  good,  46-50; 
for  present  goods,  116-125; 
132-137;  influence  on,  of  cost 
of  production,  54,  55;  influ- 
ences back  of,  50^57;  joint, 
71,  72;     relation  of,  to  utility, 

Democracy,  classification  of  in- 
comes as  earned  and  unearn- 
ed a  first  step  in  inquiry  into 
nature  and  possibility  of  eco- 
nomic, 4. 

Deposits,  of  commercial  bank, 
nature  of,   38,   39. 

Depression,  view  of  Davenport 
regarding,    discussed,    49-50  n. 

Disutility,  dependence  of  supply 
on,  58,  59;  of  labor,  in  rela- 
tion to  amount  of  labor  per- 
formed, 58,  59;  marginal, 
53  ;     relation  of,  to  utility,  52. 


E 


Ely,  view  of,  regarding  relation 
of  productivity  to  interest, 
criticized,  136. 


Factors,  of  production,  76-78 
Fetter,  view,  of,  that  productiv- 
ity theory  begs  the  question, 
criticized,  129. 
Fisher,  criticism  by,  of  Bohm- 
Bawerk,  criticized,  122,  123 ; 
view  of,  that  all  loans  are  to 
provide  present  income  to 
those  desiring  the  loans,  criti- 
cized, 124-129;  view  of,  re- 
garding similarity  of  interest 
and  rent,  criticized,  203  ;  view 
of,  regarding  abstinence  the- 
ory, stated,  103  n ;  view  of,  re- 
garding nature  of  risk,  cited, 
30  n;  Elementary  Principles 
of  Economics,  cited,  65  n;  The 
Purchasing  Poiuer  of  Money, 
cited,  38,  41,  147.  156;  The 
Rate  of  Interest,  cited,  79,  119, 
128,  148,  153,  154. 


George,   Progress    and    Poverty, 
cited,   100,   195  n,  242,   245. 
H 

Hadley,  Economics,  cited,  214. 
I 

Immigration,  in  relation  to 
wages,    197. 

Impatience,  relation  of,  to  rate 
of  interest,  118-137;  see,  al- 
so,   time-preference. 

Incomes,  test  of  earned  and  un- 
earned, 3,  4. 

Increment,  of  land  values  in  re- 
lation to  the  settlement  of  the 
American  West,  217-224;  see 
Unearned  Increments. 

Increments,  of  value,  taxation  of 
future,  235-238;  see  Unearn- 
ed increments. 

Inheritance,  justification  of,  in 
case  of  capital  produced  by 
human  labor,  222-223. 

Interest,  justification  of,  com- 
pared with  justification  of 
wages,  192-194. 

Interest,  on  capital,  comparison 
of  land  rent  with,  203-205 ; 
the  causes  of,  76-1  u;  the 
rate  of,  1 12-170;  saving  or 
abstinence  in  relation  to,  96- 
107. 

Jevons,  The  Theory  of  Political 
Economy,  cited,  5,  11,  64,  92  n, 
117,  i6i. 

L 

Labor,  demand  for,  172-178  ;  re- 
lation of,  to  cost  of  production, 
62-66. 

Land,  conditions  of  supply  of, 
distinguished  from  those  of 
most  other  goods,  61,  62;  de- 
mand for,  not  affected,  as  in 
case  of  other  goods,  by  possi- 
bility of  producing,  55~57*. 
distinguished  from  other  goods 
by  conditions  fixing  amount  of, 
76-78;  in  relation  to  cost  of 
\        production,    66-70;       rent    of. 


Index. 


257 


compared  to  interest  on  capi- 
tal, 203-^205 ;  rent  of,  as  a 
marginal  product  of  land,  199- 
203  ;  rent  of,  as  an  imearned 
income,  205-208 ;  rent  of,  tax 
on,  cannot  be  shifted,  201- 
203  ;  the  rent  of,  and  its  tax- 
ation, 199-254;  the  value  of, 
70,  71 ;  taxation  of,  in  relation 
to  the  theory  of  vested  rights, 
238-244. 
Landowners,  right  of,  to  a  re- 
turn on  improvements  paid  for 
by  special  assessments.  209- 
212;  various  services  of, 
other  than  paying  assessments, 
212-217. 

M 

Marshall,  Principles  of  Econom- 

ics    cited    72. 
Mill,'     Principles      of      Political 

Economy,  cited,  73,  98,  173  n. 
Minimum  price,  of  wheat,  guar- 
antee   of,     by     United     States, 

during  war,  14  n. 
Money,    use    of,    in    relation    to 

rate  of  interest,  145-147- 
Monopoly,  price  fixed  by,  27,  28 ; 

return  to,  a  case  of  exploitation 

of  consumers,  234. 


Overproduction,      possibility      of 
general,  47"50. 


Physiocrats,  doctrine  of,  regard- 
ing shifting  of  taxes,  discussed, 
282  n. 

Population,  general  wages  and, 
194-197;  limitation  of,  in  cer- 
tain families,  in  relation  to 
right  to  enjoy  land  rent,  225- 
229;     wages  and,  171-198. 

Price,  demand  and  supply  in  re- 
lation to,  16-28;  market,  sea- 
sonal and  normal,  18,  20;  mo- 
nopoly, 27,  28 ;  only  one  in 
a  given  market  at  one  time,  23, 


24;  regulation  of,  27,  27-8  n, 
28 ;  speculation  in  relation  to, 
28-31. 
Prices,  determination  of  the 
general  level  of,  31-37;  re- 
lation of  commercial  banking 
to  the  general  level  of,  38-42; 
rising  and  falling,  in  relation 
to   interest,   152-156. 

Production,  conditions  determin- 
ing extent  of  an  isolated  man's, 
10,  11;  the  factors  of,  76- 
78;  labor  costs  in,  62-66; 
land  and  capital  costs  in,  66- 
70;  measurement  of  time  in- 
volved in  roundabout,  116- 
118;  possibility  of  general 
over — ,  47-50;  relative,  of 
different  goods  in  relation  to 
utility  and  value,  12-16; 
roundabout,  advertising  as 
sometimes  a  case  of,  163,  164; 
roundaboutness  of,  increased 
by  the  diverting  of  labor  to 
more  remote  ends,  81-85; 
roundaboutness  of,  increased 
by  the  diverting  of  the  factor 
land  to  more  remote  ends,  85- 
87;  roundaboutness  of,  in- 
creased by  the  diverting  of 
capital  to  more  remote  ends, 
86;  roundaboutness  of,  illus- 
trations of  ways  of  increasing, 
87,  88. 

Productiveness,  of  capital,  in  re- 
lation to  amount  of  capital  ac- 
cumulation, 89-96. 

Productivity,    of    capital,    79-88; 
of     labor,      influence     of,     on 
wages,  183-185. 
R 

Rae,  referred  to  as  having  de- 
developed  theory  of  accumu- 
lation,  79  n. 

Regulation,  of  price,  27,  27-8  n, 
28. 

Rent,  of  land,  and  its  taxation, 
199-254;  compared  to  inter- 
est on  capital,  203-205;  as  a 
marginal  product  of  land, 
199-203;      tax   on,    cannot    be 


258 


Index. 


shifted,  201-203 ;      as   unearn- 
ed  income,  205-208- 

S 

Saving,  or  abstinence,  in  rela- 
tion to  interest,  96-107. 

Seager,  "The  Impatience  Theory 
or  Interest,"  cited,  125,  131. 
Senior,  Outlines  of  the  Science 
of  Political  Economy,  cited,  76, 
101. 

Speculation,  in  relation  to  price, 
28-31. 

Supply,  definition  of,  18,  19;  de- 
mand and,  in  relation  to  price, 
16-28;  dependence  of,  on 
disutility,  58,  59;  dependence 
on,  of  utility,  59;  influence 
on,  of  cost  of  production,  59- 
61 ;  influences  back  of,  57- 
62;  joint,  72,  73;  of  one 
good,  in  relation  to  demand 
for  other  goods,  46-50;  of 
present  goods  offered  for  fu- 
ture goods,  125-137;  possi- 
bility of  general  over — ,  47- 
50. 

T 

Taussig,  Principles  of  Econom- 
ics, cited,   72,   236. 

Tax,  on  land  rent,  cannot  be 
shifted,  201-203. 

Taxation,  ability  theory  of,  dis- 
cussed in  relation  to  tax  on 
land  rent,  247-249 ;  of  fu- 
ture increments  of  value,  235- 
238;  of  land  values,  in  rela- 
tion to  the  theory  of  vested 
rights,  238-244;  the  rent  of 
land  and  its,  199-254. 

Time-preference,  relation  of,  to 
rate  of  interest,  137-145;  see 
impatience. 

U 
Unearned  increments,  bearing  of 
the  contention  that  there  may 


be  some  not  associated  with 
land,  230-235;  see  increment. 
Utility,  decline  of,  with  addi- 
tional amounts  of  a  good,  8, 
51;  marginal,  52;  relation 
of,  to  demand,  51-53  ;  relation 
of,  to  price,  51,  52;  relation 
of,  to  supply,  59;  relative  pro- 
duction of  different  goods, 
value  and,  in  a  modern  com- 
munity,  12-16. 


Value,  or  analogue  of,  to  isolated 
man,  5-10;  the  determina- 
tion of,  5-45 ;  of  land,  70, 
71;  nature  of,  5;  ultimate 
determinants  of,  46-75  ;  util- 
ity, relative  production  of  dif- 
ferent goods  and,  in  a  modern 
community,    12-16. 

Veblen,  view  of,  regarding  usu- 
fruct by  capitalists,  of  imma- 
terial technological  equipment 
of  the  race,  criticized,  168  n. 

Vested  rights,  land  value  taxa- 
tion in  relation  to  the  theory 
of,    238-244. 

W 

Wages,  comparative,  in  different 
labor  groups,  185-191 ;  popu- 
lation and,  171-198;  general, 
and  population,  194-197;  im- 
migration and,  197;  influence 
of  productivity  of  labor  on, 
183-185;  justification  of  in- 
terest in  relation  to  justification 
of,  192-194;  the  proximate 
determination   of,    171-183. 

Walker,  Political  Economy,  cited, 
236. 

White,  Money  and  Banking, 
cited,  41. 


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